Gas and diesel prices likely to stay elevated as oil refining margins hit a record high

Though crude oil (BZ=F, CL=F) prices have ticked up as military activity between the US and Iran reignited, they remain far off their wartime highs.

But red flags are flashing in the refining market for critical products such as gasoline, diesel, and jet fuel. “Crack spreads,” or the price difference between crude oil and the refined product, keep growing.

That means despite the drop in oil prices, the “underlying physical reality is still much tighter,” Jordan Rizzuto, chief investment officer of GammaRoad Capital Partners, told Yahoo Finance.

“So the market pricing likely may have gotten ahead somewhat of the physical reality,” he added.

The most closely watched spread is the “3-2-1 crack,” which estimates the theoretical margin gained from turning three barrels of crude oil into two barrels of gasoline (RB=F) and one barrel of distillate fuel. On Wednesday, that crucial measure pushed past $60 to reach an all-time high.

Saxo Bank head of commodities Ole Hansen attributes the tightness to two factors: strong seasonal demand for products such as gasoline and constrained availability.

As governments and companies drew down their jet fuel and gasoline stores during the Iran war, refineries struggled to obtain crude oil to replenish their inventories, driving prices higher. The dynamic has played out just as the US hit the summer vacation season, when demand for gasoline spikes.

Read more: How the Iran war drives up the cost of gas and groceries

Another critical factor is global refinery outages. Throughout the US-Iran conflict, at least nine major oil refineries in the Gulf region — including Bahrain, Kuwait, and Saudi Arabia — were damaged and shut down.

Additionally, in the four years of the Russia-Ukraine conflict, at least 18 refineries throughout Russia have been impacted.

Moscow announced on Wednesday that the country, which supplies roughly 10% of the world’s diesel, would be suspending diesel exports. That sent the 3-2-1 crack roaring upward to its all-time high.

Even outside of conflict zones, the global refining complex has seen a string of major incidents. Explosions and fires at Australia’s Geelong refinery in April have disrupted petrol production. In the US, a major explosion at the Valero Port Arthur refinery in Texas shuttered multiple units.

In the Middle East, “The key question is what share of the region’s 11.7 mbd of refining capacity is immediately restartable and what portion requires extensive repairs,” JPMorgan head of commodities research Natasha Kaneva wrote in a client note on Thursday.

The bank’s base case is that only 250,000 barrels per day of capacity will remain shut down by the end of the year due to hopes of a ceasefire. However, “confidence around this estimate remains low,” Kaneva wrote.

While the dynamic is tough on consumers, it’s been a boon for the refiners.

Shares in Valero Energy (VLO) and Phillips 66 (PSX), two of the country’s major refiners, are up 51% and 33%, respectively, over the past six months. Marathon Petroleum (MPC), the largest US publicly traded refiner, has gained an even stronger 60%.

The picture isn’t likely to change soon, noted Sumit Ritolia, an oil refining analyst at intelligence firm Kpler. “While crude availability is expected to improve over the coming months, refined product supply is likely to respond with a meaningful lag,” he said.

The Gulf region needs time to restart its refining complex once the US and Iran conflict winds down, which now looks like a further-off goal. Russia’s capacity could remain severely degraded for months. At the same time, China has kept its oil imports subdued and maintained export quotas on its refinery products.

Limited refined product inventories globally “reduce the market’s ability to absorb refinery outages, weather disruptions, unexpected outages, or demand strength, increasing the likelihood of stronger price responses to supply shocks,” Ritolia wrote.

Refineries throughout the US, Europe, and India pushed off critical annual maintenance, usually conducted in the spring, to maximize production during the first wave of the Iran war. That maintenance will likely have to occur in the fall, per Kpler.

All of this should keep refining margins elevated even if crude prices keep coming down. “The normalisation of crude markets,” Sotalia wrote, “does not imply a similar normalisation in refined products cracks and refining margins.”

Jake Conley is a breaking news reporter covering US equities for Yahoo Finance. Follow him on X at @byjakeconley or email him at [email protected].

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