Soaring Oil Freight Costs Threaten Refinery Margins and Fuel Supply

What happened

Shipping costs for crude oil and refined products are on the rise, directly impacting the profit margins of refineries. This increase in operational costs is making refining less profitable, leading to the possibility that refineries may reduce their utilization rates or even cut production. This situation occurs at a time when the global fuel market is already tight.

Why it matters

The increase in freight costs, by compressing refinery margins, could result in a decrease in the supply of refined products such as gasoline, diesel, and jet fuel. If refineries choose to cut production to preserve profitability, it means less fuel available in the market. A tighter supply in a scenario of relatively stable or growing demand tends to push fuel prices higher. This, in turn, has the potential to fuel widespread inflationary pressures, affecting everything from the cost of transporting goods to consumer purchasing power. For central banks, such as the Fed and the ECB, the persistence of energy-related inflationary pressures could influence their monetary policy decisions, potentially leading to a more hawkish stance or maintaining high interest rates for longer.

Market impact

• Interest rates and bonds: Higher fuel prices, if persistent, can contribute to higher inflation. This tends to lead central banks to keep interest rates higher for longer or even consider further increases, negatively impacting bond prices (especially long-term ones) and raising their yields.
• Dollar and exchange rates: In a scenario of global inflation driven by energy, the US dollar may strengthen as a safe haven, especially if the US economy shows resilience. Currencies of oil-importing countries, such as the Brazilian real, may depreciate due to increased import bills and inflationary impact.
• Equities: Energy-intensive sectors, such as transportation and manufacturing, may see their margins compressed, affecting corporate profits and, consequently, stock performance. Energy companies (exploration and production) may benefit from higher oil prices, but refineries may be penalized. The risk of inflation and high interest rates tends to be negative for the overall stock market.
• Commodities: Crude oil prices tend to be driven upwards, as the prospect of refinery production cuts suggests a tighter supply of finished products, which could translate into higher demand for crude oil for refining, or, alternatively, the perception of a tighter energy market in general. Other commodities may be indirectly affected by transportation costs.
• Brazil: Brazil, as an oil producer and exporter, may see an initial benefit in its trade balance from higher oil prices. However, rising fuel prices at the pump tend to pressure domestic inflation, impacting purchasing power and potentially requiring a more cautious stance from the Copom regarding the Selic rate.

What to watch

It will be crucial to monitor the earnings reports of major refineries to verify the actual impact of freight costs on their margins. Additionally, data on global refinery utilization rates, as well as refined product inventories, will provide indications of the extent of production cuts. Any statements from major shipping companies or industry analysts regarding freight cost dynamics will also be important. Finally, consumer price index (CPI) data in key economies, with a focus on the energy component, will be essential to assess the macroeconomic impact.

Scenarios

Base Case: Freight costs remain elevated, leading to moderate cuts in refinery production. This results in a gradual increase in fuel prices and persistent, but manageable, inflationary pressure that keeps central banks on alert. Risk Scenario: Freight costs soar further, forcing significant cuts in refinery production and creating fuel shortages. This would lead to a severe inflationary shock and a more aggressive response from central banks, with the potential for a global economic slowdown.

Original source: Bloomberg Markets. For information only, not investment advice.