Oil prices have just come off a fresh two-month high as the crude oil market has tumbled this week amid signals of de-escalation in the U.S.-Iran conflict.

Despite the slump in crude prices and the extreme volatility in the past five months, the refined product market continues to tighten with refining margins at record highs because the supply of petroleum products is much tighter than crude supply.

Refining margins held at record highs even as crude oil prices soared last week to $100 per barrel. That’s because global gasoline, diesel, and jet fuel supply is tightening and has been tightening for months amid a combination of factors, most stemming from the wars in Iran and Ukraine.

While crude oil futures largely reflect market hopes and fears for prices ahead, the gasoline and diesel refining margins, supply, and prices reflect the real-time situation with refinery throughput, global fuel flows, and availability in various markets.  

Record High Refining Margins

Earlier this month, refining margins for gasoline and diesel jumped to new record highs after the re-escalation (currently on hold) in the Middle East, Russia’s ban on diesel exports, and crumbling global fuel inventories.

As a result, the rally in refining margins and fuel prices has vastly outrun any spikes in crude oil prices in recent weeks. 

The surge in fuel margins and the price spread over crude prices suggest that the global fuel markets remain very tight despite the millions of barrels of crude that have managed to exit the Strait of Hormuz between the middle of June and early July.

Diesel refining margins in Europe jumped to a record high of over $60 per barrel after Russia announced a ban on diesel exports in a bid to ease its domestic fuel crisis caused by a spate of Ukrainian drone attacks on Russian refineries.  

In addition, gasoline in Europe traded at a four-year high premium to crude of $41 per barrel. The last time European gasoline traded at such a high premium over Brent Crude was in the summer of 2022, in the early months of the Russian invasion of Ukraine.

In the United States, the prompt NYMEX 3-2-1 crack spread contract, which is considered a proxy for refinery profitability, hit a record high, too.

The 3:2:1 crack spread broke above its June 2022 record near $60 to fresh all-time highs near $64 in the middle of July.

Tighter availability amid export bans and multi-year low fuel inventories in many countries, including the United States, also pushed higher refining margins and fuel spreads over crude.

“Diesel cracks and gasoline cracks soared to their strongest level in four years, highlighting robust product demand despite the sharp increase in crude prices,” analysts at RBN Energy said last week when crude prices rallied by 20%.

“Rather than eroding refining economics, higher crude prices were more than offset by stronger product values, allowing refiners to preserve historically attractive margins,” RBN Energy added.

Despite high capacity utilization in the United States, global fuel markets are tight as inventories are low and record-high U.S. oil and fuel exports cannot offset all the supply lost in the Middle East.

U.S. commercial oil stocks remain 6% below the five-year average for this time of year, despite a build in the latest reporting week to July 17, while stocks at Cushing, Oklahoma, and in the Strategic Petroleum Reserve (SPR) are at multi-year and four-decade lows, respectively.

In a sign of tightening fuel markets, U.S. wholesale diesel futures have jumped by 26% so far in July.

Elsewhere, Asian refiners that had bet on a flood of crude supply from the Middle East in August are now facing potential delays in deliveries amid the renewed closure of the Strait of Hormuz and the slower traffic at the other key chokepoint, the Bab el-Mandeb on the Red Sea. These expected delays could thwart Asian refiners’ plans to ramp up crude processing rates in the coming weeks.

Fuel Markets Could Tighten Further

“Currently refineries in Asia (except China) are operating at high runrates (~80%), but expecting this would reduce by end Aug as the prompt delays in crude arrivals from the Middle East weigh on the operating feasibility of the sites,” June Goh, Senior Oil Analyst at Sparta Commodities, said in an analysis on Monday.

Tight fuel markets don’t bode well for inflation and economies globally as they depend on diesel for agricultural and road freight activities, analysts warn.

For months, experts have cautioned that the real crunch in the oil market is in the refined products, and fuel margins and prices should be seen as the gauge of how the world is grappling with the Middle East crisis, as crude oil futures trade is mostly driven by fears, hopes, and greed.  

In a rare statement last week, Fatih Birol, the executive director of the International Energy Agency (IEA), said that “There is no room for complacency on oil security amid the escalation in hostilities and a continued drawdown of available commercial inventories.”

While assuring markets that IEA countries still hold more than 1 billion barrels of government-controlled stocks, Birol said that “Refinery activity and product supplies have not picked up as much as crude deliveries, meaning that markets for refined oil products, including diesel and gasoline, are considerably tighter than those for crude.”

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