Key takeaways
- European diesel refining margins remained at $85.34 per barrel above Brent crude, approximately 7 per cent below their recent record.
- Traffic through the Strait of Hormuz fell to one-quarter of its recent average while a key European storage hub recorded no new imports.
- Elevated margins favour refiners but threaten transportation, agriculture and consumer prices as winter approaches.
European diesel refining margins edged lower Friday but remained near record levels as disruptions in the Middle East and Russia continued to restrict global fuel supplies.
Low-sulphur gasoil futures traded at a premium of $85.34 per barrel over Brent crude, down only 30 cents from Thursday’s close. The benchmark reached an all-time high of $91.67 earlier in the week.
The small decline therefore provides little evidence that the diesel shortage is easing. Refining margins remain more than large enough to support strong profits for companies capable of keeping their facilities operating.
What the margin measures
The difference between the price of diesel and the crude oil used to produce it is commonly called a crack spread.
It provides an approximate measure of how much a refinery can earn from processing crude into fuel before accounting for operating, transportation and maintenance costs.
A widening spread generally indicates that refined fuel is becoming scarcer relative to crude oil. That distinction is important in the current market because the shortage is primarily a problem of available refining capacity and fuel distribution, rather than a simple lack of crude.
Industry executives estimate that disruptions have removed approximately two million barrels per day of refined products from Russia and nearly two million barrels per day from the Middle East.
Most remaining refineries are already operating close to capacity. Producing more diesel therefore requires existing plants to run harder, restart damaged equipment or divert production away from gasoline and other fuels.
Hormuz traffic remains severely disrupted
Only four commodity vessels passed through the Strait of Hormuz on Thursday, down from six one day earlier and well below the 10-day average of approximately 16 vessels.
The waterway connects major Gulf producers with international markets and normally carries substantial quantities of crude oil and refined products.
Restricted vessel movements increase shipping costs and make it more difficult for European buyers to replace fuel previously supplied by Russia and the Middle East.
European inventories are not yet showing meaningful improvement. Gasoil and diesel stocks at the Amsterdam-Rotterdam-Antwerp storage hub remained almost unchanged at 1.65 million metric tons, with no imports recorded.
Eight cargoes are scheduled to arrive before the end of September. Those deliveries could provide some relief, but traders will be watching whether they actually increase inventories or are immediately absorbed by existing demand.
The approach of winter adds further pressure because diesel-related fuels are used for heating as well as transportation. Seasonal refinery maintenance could also temporarily remove additional production capacity.
Refiners benefit from wider spreads
Persistently high crack spreads can support earnings at refiners including Valero Energy Corporation (NYSE:VLO), Phillips 66 (NYSE:PSX) and Marathon Petroleum Corporation (NYSE:MPC).
Each additional barrel processed becomes more valuable when fuel prices rise faster than crude costs. However, companies can only capture that advantage if their refineries remain operational.
Running facilities close to maximum capacity increases the financial consequences of unplanned outages. Rising crude, shipping and maintenance expenses can also absorb part of the apparent benefit.
Political intervention is another risk. European governments are facing pressure to reduce fuel prices through subsidies, tax cuts, price controls or windfall taxes on energy companies.
The largest integrated producers may also experience mixed effects because stronger refining profits can be offset by weakness elsewhere in their operations.
Higher diesel prices spread through the economy
The consequences extend beyond energy companies.
Average U.S. diesel prices reached a record $6.29 per gallon this week, representing an increase of 68 per cent from one year earlier, according to the U.S. Energy Information Administration.
Diesel powers most heavy trucks, agricultural machinery and construction equipment. Higher prices therefore increase the cost of harvesting crops, transporting goods and completing infrastructure projects.
Union Pacific Corporation (NYSE:UNP) said rising diesel costs were encouraging some customers to move freight from trucks to rail. Railways are generally more fuel-efficient over long distances, although they also face higher operating expenses when diesel prices increase.
Food inflation is another potential consequence. Farmers must continue running combines and tractors during harvest season regardless of fuel prices, while most food ultimately reaches stores by truck.
Why investors should care
Friday’s modest decrease in diesel margins should not be confused with a return to normal market conditions.
A sustained recovery would likely require increased traffic through Hormuz, the restoration of Russian and Middle Eastern refining capacity and several consecutive inventory builds in Europe and the United States.
Until then, high margins could support refinery earnings while placing additional pressure on transportation companies, manufacturers and consumers.
Investors should monitor European inventory reports, incoming cargoes, refinery outages and Hormuz shipping activity. Those indicators will show whether the recent record margins are beginning to retreat or whether the diesel shortage will persist through the winter.