Key facts
- Geopolitical tensions in the Middle East have led to a sustained increase in oil prices.
- Global and U.S. oil inventories are critically low, with U.S. Strategic Petroleum Reserve at its lowest since 1983.
- Damage to refineries and disruptions in Russian output have tightened fuel supply.
- Despite potential drops in crude prices, fuel prices are expected to remain elevated due to supply constraints.
- Resilient demand, coupled with tight supply, suggests a 'higher-for-longer' oil price scenario.
Oil prices have been on an upward trend for over a week, driven by ongoing hostilities in the Middle East and signs of physical market tightness, suggesting a prolonged period of higher prices. Initial forecasts of an oil glut have been undermined by the breakdown of a U.S.-Iran ceasefire, leading to renewed disruptions in traffic through the Strait of Hormuz and sporadic tanker crossings.
The International Energy Agency (IEA) reported that while global oil supply rebounded in June, it remains significantly below pre-war levels. Drawdowns from oil inventories have continued, with OECD crude stocks experiencing substantial decreases in recent months. The United States is particularly affected, with inventories at Cushing, Oklahoma, reaching minimum operational levels and the Strategic Petroleum Reserve (SPR) at its lowest point since 1983. Experts warn that further draws could compromise storage facilities and that higher prices are necessary to achieve demand destruction.
The discrepancy between crude oil prices and fuel prices is widening. The gasoline crack spread has increased, and gasoline prices have risen more significantly than crude oil since pre-war levels. This is attributed to damaged refineries in the Middle East, Ukrainian drone attacks on Russian output, and a subsequent ban on Russian diesel exports. Unlike crude oil, there is no comparable stockpile cushion for refined fuels.
While President Trump's social media posts can cause temporary fluctuations in crude prices, these are unlikely to translate into immediate fuel price declines. The reduced processing capacity in Middle Eastern refineries and the significant impact of drone attacks on Russian refining capacity, which supplies a substantial portion of the world's diesel, contribute to tight fuel markets.
Demand for fuel, particularly diesel, has remained resilient despite some destruction, due to the global economy's heavy reliance on these commodities. Governments often intervene to shield consumers from price shocks, making demand destruction a challenging, albeit necessary, mechanism for price stabilization. Consequently, fuel prices are expected to remain elevated for an extended period.