Fuel Prices: Refining Margins Rise Alongside Crude Oil

Since mid-July, Brent crude prices have rebounded by nearly $20 per barrel. But this headline figure masks an even more striking development: European diesel refining margins, which measure the difference between the price of crude and the refined product, have risen even faster, from $37 to almost $65 per barrel, a record high. Refining consists of “cracking” crude-oil molecules into smaller molecules, in this case diesel.

Several factors explain this rise. The closure of the Strait of Hormuz has, of course, constrained refined-product supplies from the Gulf. Other contributors include the loss of around half of Russia’s refining capacity; Chinese output running at a very low level, down 18% year-on-year according to Morgan Stanley; US export flows being directed towards Brazil rather than Europe; and the start of the German heating-oil tank refill season, from unusually low inventory levels.

Our analysis

What households and transport operators ultimately pay is the retail price of fuel, not the price of Brent. The main risk for the European economy would be a further increase in crude prices combined with refining margins remaining elevated. In such a scenario, retail fuel prices could exceed their April levels.

This would have two implications. First, it would push up energy inflation at a time when central banks remain highly alert to potential second-round effects. Second, it could eventually lead to weaker physical demand as industrial activity, transport, freight and consumer spending slow.

Restoring refining capacity is therefore critical to avoiding this outcome. Some of these technical factors could normalise over the coming months, even if the geopolitical situation remains unchanged. However, visibility on refining availability in both the Gulf and Russia has deteriorated.