Why Hormuz windfall may prove short-lived for oil refiners

LONDON: Oil refiners around the world have seen profits surge thanks to a rare combination of robust fuel demand and weak crude prices, as markets have rapidly readjusted following the reopening of the Strait of Hormuz. The windfall is unlikely to last. The benchmark U.S. 3-2-1 crack spread , a widely watched measure of refining profitability, recently climbed above $60 a barrel, the highest level on record. Refining margins in Asia and Europe have also risen sharply.

Refining profitability is determined by two factors: the cost of crude oil and the price of the gasoline, diesel and jet fuel produced from it. At the moment, both are moving in refiners' favour.

CRUDE AWAKENING

When it comes to feedstock costs, the tide has turned dramatically since the U.S. and Iran signed an interim ‌ceasefire agreement on June 17. Only last ⁠month, crude ⁠markets were grappling with an extreme supply shortage caused by the closure of the Strait of Hormuz. Today, the market is instead being flooded by hundreds of millions of barrels that had been stranded in the Gulf during the blockade. Total Middle ​East crude exports, including volumes shipped through ports in Saudi Arabia and the United Arab Emirates that bypass Hormuz, rose to 12.35 million barrels per day in June from less than 8 million bpd ​in May, according to Kpler data. July exports are currently expected to reach 12.5 million bpd, Kpler estimates.


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Although regional exports remain well below their pre-war average of around 18 million bpd, the sudden release of large volumes of crude has created a temporary glut. That shift is reflected in global benchmark Brent crude futures , which have retreated to around $70 a barrel, roughly where they traded ​before the Iran conflict erupted on February 28 and $50 below the wartime peak. Conditions in the physical market are even more ⁠bearish. Gulf producers, ‌particularly Saudi Arabia and the UAE, are competing for market share, leading to aggressive pricing and discounts on cargoes.

This dynamic could persist for months. Producers are ​not only releasing crude stored ​on tankers and in onshore facilities, but also bringing back oilfields that were shut during the conflict. The result is a growing wave of ⁠supply hitting a global market facing questions about demand growth.

A RARE WINDFALL

Refiners are also enjoying a windfall on ​the products side of the equation.

Fuel prices remain remarkably strong, reflecting exceptionally tight inventories after months of disruption. In the U.S., the world's largest oil consumer, gasoline refining margins have surged by more than 60% since early June to over $56 a barrel, approaching the record highs seen during the energy crisis of June 2022 following Russia's invasion of Ukraine. The strength comes as the U.S. enters the peak summer driving season with gasoline inventories for this time of year at their lowest level in more than a decade. Stocks were heavily depleted during the Iran war as U.S. refiners boosted exports to help compensate for shortages elsewhere in the world.

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Diesel markets are displaying a similar pattern. Benchmark European diesel refining margins climbed above $50 a barrel as global inventories fell sharply in recent months, leaving consumers with very little buffer against supply disruptions. The outlook has tightened further following a steep decline in Russian diesel exports ‌caused by repeated Ukrainian drone attacks on Russian refineries, a situation that appears to be getting worse.

THE SPOILS OF A PRICE WAR

One sign of how unusual today's market conditions are is the extraordinarily thin gap between crude prices and refinery margins. The spread between U.S. benchmark West Texas Intermediate crude prices (WTI) and the ​3-2-1 crack spread is currently ​at its narrowest level in around a decade, excluding ⁠a brief period during the COVID-19 pandemic when WTI collapsed into negative territory.

Historically, such a relationship is difficult to sustain. Strong fuel demand usually translates into stronger crude demand as refiners compete for feedstock, pushing oil prices higher.

Something ultimately has to give: either crude prices will rise, fuel prices will fall, or both.

For now, the outlook for fuel markets remains supportive. Given the ​extreme tightness in global inventories, demand for gasoline, diesel and jet fuel is likely to remain robust for several months.

The most likely outcome is that crude prices will rise as today's mini-glut fades and stored barrels are absorbed by the market in the next few months. That would gradually erode refiners' exceptional margins, bringing profitability back toward more normal levels.

Refiners are currently enjoying a rare sweet spot. But the post-war bonanza may prove as short-lived as the market dislocation that created it.


The opinions expressed here are those of Ron Bousso, a columnist for Reuters.