(Bloomberg) — In the world of central banking, scrutinizing profit margins from refining crude oil probably hadn’t been seen as critical when it came to setting interest rates. Then energy markets started screaming chaos again.
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While Brent crude futures surged above $100 this week, louder alarm bells are ringing over the prices of fuels that heat homes, power industry and keeps trucks moving around the world. They are showing even greater pressure than the headline oil price and threaten to have a wider impact on the economy.
For much of the Iran war, central bankers were able to ignore the energy supply hit from the conflict because worst-case scenarios were avoided. But while oil surges again, the prices of diesel and natural gas are climbing even faster in part as the Iran war shows little sign of a solution. Both sides show they could be gearing up for a protracted conflict.
The European Central Bank highlighted higher oil and gas prices as one of the potential risks pushing its inflation forecasts higher in the coming months.
“If I had talked to you about refining margins six months ago, we wouldn’t have known what we are really talking about,” ECB President Christine Lagarde said on Thursday after delivering a widely anticipated increase in the cost of borrowing. “Now, whether you call it the crack spread or the refining margin, on liquid fuel, now we all know what it’s about.”
Earlier in the week, Bank of England Governor Andrew Bailey gave UK politicians a lesson in oil-market economics in parliament, noting that crack spreads — the premiums oil refiners make when they turn crude into consumable products like gasoline and diesel — are adding to price pressures. Markets are now expecting two increases in interest rates by February to help tackle inflation.
Diesel futures in some parts of the world are north of $200 a barrel, and with taxes some consumers are paying more than $300. Europe’s natural gas prices hit the highest since late 2022, the year of Russia’s full-scale invasion of Ukraine, as inventories remain thin before the weather turns colder. Diesel prices in the US are also at a record.
The situation is still far from the disaster scenarios when the Iran conflict started at the end of February. One of the big drivers of the rally of the past few weeks has been China, and it remains to be seen if the Asian country’s refiners will continue to be so given the costs.
But the broader trajectory is clear. Traders and producers say the world needs oil heading into winter and refinery capacity is still constrained so that’s going to keep stressing fuel costs. Ukraine’s attacks on Russian refineries have brought its diesel exports to a record low, while Middle Eastern processing plants are still recovering from attacks early in the Iran war.
There remains a gap between current and prewar flows through the Strait of Hormuz, which before the war accounted for about a fifth of the world’s oil and liquefied natural gas flows.
Many of the energy market’s workarounds have been shut off. Strategic reserve releases are slowing, while China has been buying more oil and stockpiles have steadily dwindled.
Yemen’s Houthi militants have also been repeatedly attacking Saudi Arabia, one of the world’s biggest oil and gas producers. Following multiple attacks on Thursday, the kingdom closed its East-West pipeline, a key alternative to the Strait of Hormuz for its exports.
The oil market is signaling upheaval. The cost of hiring a supertanker for a day could pass $1 million, while vast premiums are being paid to secure immediate supply. Derivatives contracts that usually move a few cents at a time are surging to records and gaining several dollars in single trading sessions.
“We’re going to see a very difficult winter coming in Northern Europe,” Shaikh Khaled Al-Sabah, managing director for international marketing at Kuwait Petroleum Corp., said at a conference this week. “This is only the beginning.”
Gas has largely remained stranded in the Gulf. European traders are fretting over how much they can secure through winter, with inventories at a record low for the time of year.
Governments and companies held off buying over the summer, but major banks and consultants have said the amount of gas the region needs to purchase could push prices back above €100 a megawatt-hour, about 25% higher than current levels. High gas prices ultimately hit industrial production.
“This is a difficult period,” said Evangelos Mytilineos, executive chairman of Greek company Metlen, the largest integrated producer of bauxite, alumina and primary aluminum in the European Union. “Electricity prices are reaching levels at which companies which are not adequately prepared can’t produce aluminum.”
In crude markets, the world’s main benchmark for real world barrels hit $120 for the first time since June. It’s a sign that refiners are paying up to process whatever barrels they can get hold of as the profit from making fuel, notably diesel, remains historically high.
Indeed, the warnings around diesel in particular are growing louder. Ukrainian strikes on Russian oil refineries have slowed one of the world’s biggest sources of diesel exports to a trickle.
“We all know that diesel is used by a category of economic actors,” Lagarde said at her press briefing this week, where she indicated that interest rates might have to go higher to contain inflation risks. “And we know now that it’s yet another bottleneck.”
At an oil conference in Singapore this week, traders repeatedly pointed to global fuel markets as facing significant issues. In some European nations, like Italy, tax cuts are already in place to shield consumers, but that pressure will persist if diesel prices keep climbing.
On Friday, the International Energy Agency said that 2026 will see the biggest decline in oil demand since the pandemic, as high diesel prices in particular hit consumption.
It said that, until now, stockpiles had been key to keeping prices in check. But those buffers were draining and the world’s refining system is stretched to the limit. Without progress in either the Iran or Russia-Ukraine wars, oil markets could get even tighter, they warned.
That brings with it the risk of a potentially painful winter and politicians having to take action to ease the cost of living while central bankers raise interest rates. Away from energy resources, attacks on Black Sea ports have helped send food prices to the highest in almost four years.
Hungary announced on Friday, for example, that it will help car owners with fuel costs.
“There are a lot of concerns that prices will further increase,” said Anne-Sophie Corbeau, a researcher at Columbia University’s Center on Global Energy Policy. “There is likely to be a call for governments to intervene and protect consumers, but of course it depends on each country’s fiscal situation.”
–With assistance from Donato Paolo Mancini, Charles Gorrivan and Anthony Di Paola.
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