Oil Majors Resist New Refinery Investments, Signaling Sustained High Fuel Prices

What happened

Major oil companies are resisting pressure to invest in building new refineries, even as fuel prices remain high. This stance comes as conflicts in the Middle East and Ukraine have slashed fuel production capacity and significantly boosted refining margins. The decision not to expand refining capacity suggests a view that current supply and demand conditions in the energy market will persist.

Why it matters

The refusal of oil companies to invest in new refineries, despite elevated margins, is a critical factor for the energy market. Reduced fuel production capacity, exacerbated by geopolitical tensions, has already resulted in higher prices. The lack of new investments implies that this supply constraint could persist, or even worsen, in the future. This means consumers and businesses may continue to face high energy costs, which has direct implications for global inflation and economic growth. For central banks like the Fed and the ECB, persistent high energy prices could complicate monetary policy management, making it harder to control inflation.

Market impact

• Interest rates and bonds: Persistent high energy prices tend to maintain inflationary pressure, which may lead central banks to adopt a more hawkish stance or keep interest rates elevated for longer. This tends to push government bond yields (Treasuries and others) upwards, as investors demand greater compensation for inflation risk.
• Dollar and exchange rates: A scenario of persistent inflation and higher interest rates in the US (to combat this inflation) tends to strengthen the dollar against other currencies. Energy-importing countries, such as Brazil, may see their currencies (like the real) depreciate against the dollar due to increased import costs and capital flight seeking safer yields.
• Equities: Stock markets may react negatively to higher energy costs, which impact corporate profit margins and consumer purchasing power. However, companies in the energy sector (oil and refining) may see their profits increase due to high margins, which could support some segments of the stock market. Uncertainty about inflation and interest rates also tends to increase overall volatility.
• Commodities: Crude oil and refined products (gasoline, diesel) tend to remain at high levels or rise further, given the refining supply constraint. Other commodities may be indirectly affected by higher transportation and production costs.
• Brazil: Brazil, as an oil producer, may see a benefit in its trade balance and government revenues. However, rising domestic fuel prices could fuel inflation, pressuring the Copom to keep the Selic rate at higher levels for longer, which impacts economic growth and the cost of public debt.

What to watch

Investors should closely monitor geopolitical developments, especially in the Middle East and Ukraine, as any escalation or de-escalation could affect production capacity and oil prices. Furthermore, it is crucial to observe the earnings reports of major oil companies to understand their investment strategies and outlook for refining capacity. Global inflation data and central bank interest rate decisions will also be important indicators.

Scenarios

Base Scenario: The lack of investment in new refineries keeps fuel prices high, contributing to persistent inflation and leading central banks to maintain a more restrictive monetary policy for an extended period. Risk Scenario: An escalation of geopolitical conflicts further exacerbates the refining capacity shortage, driving fuel prices to extreme levels and triggering a sharper global economic slowdown.

Original source: Financial Times. For information only, not investment advice.