Hormuz Crude Flows Recover, But Diesel Shortage Persists

What happened

Recent data indicates that crude oil flows through the Strait of Hormuz averaged approximately 10.3 million barrels per day last week, representing about 76% of pre-war levels. However, this recovery does not extend to refined products. Shipments of fuels such as diesel and gasoline amounted to only about 1.3 million barrels per day, roughly 11% of total flows, a significant drop from over 20% before the war.

This disparity is primarily attributed to damage to refineries in the Gulf region, including facilities in Saudi Arabia, Kuwait, the United Arab Emirates, and Iraq, which remain offline after attacks. Furthermore, major Asian refiners in China, Japan, and South Korea are retaining most of their fuel output for domestic consumption rather than exporting it. This positions the United States as one of the few large suppliers of refined fuel in a tight global market. US diesel prices hit a record high of around $6.50 per gallon last month, with analysts projecting a full supply recovery only well into 2027. Saudi crude oil exports doubled in September, reaching around 7 million barrels per day, but renewed Iranian attacks on shipping pose a significant risk.

Why it matters

The persistent shortage of refined products, especially diesel, has significant global economic implications. Diesel is an essential fuel for freight transport, agriculture, and industry, and its elevated prices directly impact production and logistics costs, contributing to inflation. The recovery of crude oil flows alone is insufficient to alleviate pressure on fuel prices, as the bottleneck lies in refining capacity and the availability of finished products. This favors refiners with operational capacity, particularly in the US, who benefit from elevated refining margins, but adds pressure on governments facing fuel-driven inflation.

Market impact

• Interest rates and bonds: Persistent inflation, driven by high diesel prices, may lead central banks to maintain tighter monetary policies for longer, or even consider further rate hikes. This tends to push government bond yields higher, especially for shorter maturities, reflecting expectations of higher rates. Treasuries may see their yields rise.
• Dollar and exchange rates: A scenario of persistent global inflation and higher US interest rates could strengthen the dollar against other currencies. Demand for assets considered safe havens during times of economic uncertainty also tends to favor the dollar. The real may depreciate against the dollar.
• Equities: Elevated fuel costs can negatively impact the profit margins of companies in transport- and logistics-intensive sectors, as well as industry and agriculture. This could lead to downward pressure on global stock indices and the Ibovespa, although refining companies with spare capacity may benefit. Inflationary uncertainty also tends to weigh on investor sentiment.
• Commodities: Crude oil prices may see some marginal relief with recovering flows, but diesel and other refined product prices are likely to remain elevated, keeping crack spreads (the difference between crude oil and its derivatives) at high levels. The risk of Iranian attacks, however, is an upside factor for both.
• Brazil: International fuel inflation translates into domestic inflationary pressure, affecting transport and production costs. This could complicate the Central Bank's efforts in managing inflation and eventually easing monetary policy, keeping the Selic rate at elevated levels for longer. The depreciation of the real could also exacerbate imported inflation.

What to watch

Investors should closely monitor the following:

• Reports on refinery recovery in the Gulf: Any progress in repairing and reactivating damaged refineries could signal an easing of refined product shortages.
• Asian fuel export data: Changes in export policies from countries like China, Japan, and South Korea could impact global diesel supply.
• Geopolitical developments in the Middle East: Escalation or de-escalation of tensions, especially attacks on shipping in the Strait of Hormuz, could directly affect oil and fuel flows.
• US and global diesel inventory reports: Low inventory levels continue to indicate a tight market.

Scenarios

Base Case: Crude oil flows remain stable or increase slightly, but the diesel shortage persists well into 2027 due to slow refining capacity recovery and Asian export retention. Diesel prices remain elevated, contributing to global inflation and maintaining pressure on central banks.

Upside Risk Scenario (for prices): An escalation in Middle East conflicts, with renewed attacks on shipping or oil infrastructure, disrupts crude oil and/or refined product flows. This would lead to a sharp increase in prices for both commodities, exacerbating the supply crisis and global inflation.

Original source: ForexLive (InvestingLive). For information only, not investment advice.