The largest-ever global oil supply shortage has topped economists’ lists of concerns since the start of the Iran war. But even as the United States and Iran resumed their blockades of the Strait of Hormuz, sending oil surging above $80 a barrel the economy faces a new problem.
Gasoline. That is, the world’s ability to make it.
The hundreds of millions of barrels of oil that exited the Persian Gulf and hit the market over the past few weeks helped add cushion to the world’s supply of oil — but they aren’t good for much of anything on their own. Oil needs to be refined into products and fuels people can use, including asphalt, plastic, heating oil, jet fuel, diesel and gasoline.
But the world’s refining capacity is deeply constrained. That’s in part because the supply chain got messed up during the war. It’s also because Iran attacked dozens of Middle Eastern refineries. And, more recently, Ukraine started blowing up Russian energy facilities.
Layer on extreme temperatures disrupting the cool conditions refineries need for proper distillation, and you’ve got yourself a big problem. Global refineries are processing 8.4 million fewer barrels of crude each day than they were before the war started — making 10% less fuel, according to Natasha Kaneva, head of global commodities research at JPMorgan.
“The question is no longer whether crude barrels will return, but how quickly the global refining system can process them,” she said.
The oil flow out of the Strait of Hormuz is by no means back to normal. A resumption of strikes in the Middle East, President Donald Trump’s declaration that the US-Iran Memorandum of Understanding is “over,” and the reimposition of a US-led naval blockade have slowed what was an encouraging ramp-up in tanker traffic through the key waterway. And Middle Eastern production is slowly coming back online, up 4 million barrels per day from May, according to Macquarie Research.
But, over the past several weeks, 200 million barrels of oil came out of the strait — adding 17 days of supply, according to Lipow Oil Associates. And crude is still getting out now despite increased military activity.
“The fundamental oil-market narrative remains unchanged: There is sufficient oil available globally as long as it can be transported to where it is needed,” said Rob Thummel, a senior portfolio manager with Tortoise Capital.
The question now is what to do with it. Demand for oil plunged during the war because supply fell sharply and many folks reduced their oil consumption. That helped keep prices lower than most analysts had expected throughout the war — but it also complicates the energy market recovery.
For example, China turned off 3 million barrels per day in refinery output, according to JPMorgan, as the government massively ramped up its coal-firing plants and electric vehicle push. China depleted its massive emergency reserves to make up for lost Persian Gulf oil, and it dramatically reduced the amount of gasoline and diesel it had been refining and exporting to neighboring countries — exacerbating widespread fuel shortages in Southeast Asia.
Before Chinese refining capacity picks up again, the government will want assurances that crude is flowing through the strait unimpeded, Kaneva predicted.
Renewed hostilities in the Persian Gulf also complicate the resumption of refining in the Middle East. The region has 11.7 million barrels per day of refining capacity, which will be difficult to turn back on again if the fuel can’t go anywhere.
An even more significant hurdle: Iran attacked 30 Middle Eastern refineries during the war, according to JPMorgan. It’s not clear yet how operable those facilities will be when they’re brought back online.
America became the gas and diesel exporter of last resort after the Middle East stopped exporting fuel during the war.
US refineries increased their output of jet fuel to help fill demand in Europe and diesel to help fill demand in Australia and Asia. That constrained America’s ability to make gas, jet fuel and diesel for its own market — one of the reasons gas prices haven’t “dropped like a rock” as Trump predicted.
Refining capacity in the United States has been a problem for years. Four refineries have closed in California so far this decade because of environmental regulations and high costs. The last new US refinery with significant capacity was Marathon’s facility in Garyville, Louisiana, which was built in 1977.
So it isn’t exactly the best time for Russia, the world’s largest fuel oil and second-largest diesel exporter (behind the United States), to … just stop exporting fuel.
Russia last week banned diesel exports after Ukrainian drones continued to bombard Russian refineries. The country has faced significant fuel shortages in recent weeks: Cars are lining up at gas stations, and fuel prices in some regions have surged 50% over the past few days.
Those outages are causing massive problems for the global diesel market, too: One fifth of the world’s reduced refinery runs have been caused by Russia’s lost capacity, JPMorgan said. Russia’s 800,000 barrels per day of exported diesel before Ukraine’s bombardment made up 12% of the world’s diesel shipments, according to Andy Lipow, president of Lipow Oil Associates.
That’s a big part of why diesel futures are up 20% over the past three weeks — and why gas and diesel prices could remain high for quite a bit longer than anyone would like, even as oil starts flowing again.
“Even as market attention remains understandably fixed on Hormuz, one of the most important determinants of global refining balances may now lie nearly 2,000 miles to the north,” Kaneva said.
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