Diesel will likely stay costly even after Hormuz reopens, Dallas Fed economists say, as up to 10% of world refining sits idle

Drivers and haulers hoping fuel prices will fall as soon as oil shipments through the Strait of Hormuz return to normal should not count on it, according to economists at the Federal Reserve Bank of Dallas.

In an analysis published Oct. 8, senior business economist Jesse Thompson and Garrett Golding, an assistant vice president for energy programs, write that the world has lost as much as 10% of its refining capacity.

Because the shortage is in refined fuel and not just crude oil, they expect gasoline, diesel and jet fuel to stay unusually expensive compared with crude for as long as that capacity stays offline.

Why fuel costs more than oil suggests

The gap between the price of crude and the wholesale price of finished fuels, known in the industry as the crack spread, has widened past levels last seen in 2022 after Russia invaded Ukraine, the economists write. They attribute the higher prices to supply problems across the global fuel market, "rather than retailer or distributor markup."

The authors list several causes. Ukrainian drone strikes cut Russia's refining capacity by as much as 60% over the summer, by some estimates, and Russia restricted its own fuel exports. The closure of the Strait of Hormuz in March, along with Iranian drone and missile strikes, reduced Middle East refinery output by about 2 million barrels a day since February.

China cut its crude imports and for a time scaled back fuel exports. Even before the war began in February, they note, diesel and jet fuel supplies were tight after years of little investment in Western refineries.

Diesel takes the biggest hit

Diesel is under the most pressure. The economists write that retail diesel has never cost so much more than gasoline, and that Europe, short of Russian and Middle East supply, has been buying more diesel from the United States.

Cushions are running low

U.S. stocks of crude oil and refined products are at multiyear lows, according to the analysis. The Strategic Petroleum Reserve held 284 million barrels in September, its lowest level since 1982, and at its current draw of 1.2 million barrels a day it could last less than six months above an official 80-million-barrel operating minimum.

Some private analysts put the true minimum much higher, the authors note, which would shorten that window.

They expect consumers to absorb the shortfall through some mix of buying less fuel, wider price swings and possibly higher prices, with effects reaching different products at different times over the next year. Damaged Middle East refineries could take months to recover, they write, so elevated spreads are likely to persist after Hormuz traffic normalizes.

The paper notes that the views are the authors' own and not those of the Dallas Fed or the Federal Reserve System.

Sources

dallasfed.org