In recent weeks, crude oil has crashed back below $80. So why is diesel still 20p above where it started the year? And why is the head of the IEA warning that we should be worried about energy security. Shipments through the Straits of Hormuz have collapsed again – down 60% in a week. We are seeing the biggest loss of absolute levels of crude oil on record, so where does this lead next?
Whilst oil prices remain relatively low, diesel doesn’t. It reflects the fact that the margins at refineries have increased in recent months to four year highs. And motorists aren’t the only ones who believe the crisis is still very real — look at the bond market. In June, oil traders assumed the crisis was over – oil prices crashed to almost pre-war levels.
But the optimism wasn’t felt by bond traders who continue to expect higher inflation and higher interest rates. Why is there such a disconnect?
Well, the world reacted to the closing of Hormuz by aggressively emptying its savings account, the US strategic reserve was at the forefront as reserves fell to lowest level since 1983. And a recent US government watchdog report suggested that the physics of getting oil out of the reserve means there may be less usable oil than previously assumed. It’s telling that this warning landed in the middle of the crisis. Perhaps Washington looks at future oil supply and doesn’t see what it likes. This fall in inventories is more than just the US, other countries such as China cut back on imports and used their inventories. But China is now re-buying. What it means is a continued shock could cause a big rise in prices because the next time, the reserves will not be there. Even if the crisis, eases, this shows potential demand from just refilling global stocks to desired levels.
This is latent demand which could push up prices.
Continued shortages
The thing is the supply that was lost in Hormuz hasn’t fully come back, overall, even after June’s partial recovery, world output was still over 9 million barrels a day below pre-war levels. Gulf refineries are still mostly offline, waiting for shipping channels to come back. Crude flows recovered to roughly three-quarters of pre-war rates in June, but refined product exports from the Gulf are still less than half — the crude came back, the diesel didn’t. Furthermore Iran hardliners have threatened to consider closing another choke point Bab el-Mandeb in the Red Sea potentially reduces another 4 million barrels per day.
Further afield, Ukrainian drone attacks are knocking out Russian refining and product exports. Don’t forget Russia is about 11% of global diesel exports! Bloomberg show how Ukrainian drones have been more effective than sanctions ever were. In Crimea, fuel sales are restricted and Russian exports of diesel products have fallen sharply. A fall in refined products particularly hurts the UK which has seen a structural decline in the number of refineries in recent years.
With Grangemouth gone, the UK lost 15% of its diesel output. Europe has also seen many refineries close since Covid, meaning Europe is more reliant on diesel imports from the Gulf. And With China halting diesel exports, this places pressure on global diesel prices.
So what we’ve seen is that crude supply is globally diversified — the US, Brazil, Canada — while diesel depends on refining capacity that’s concentrated and constrained. This explains why crack spreads hit four year highs in early July, even as Crude fell. Now, with oil prices starting to go back up, it is more likely oil prices will rise to reflect the continued demand for diesel than the other way around
Why are diesel and petrol prices slower to come down when crude oil prices fall. Well actually, in April, wholesale diesel prices rose 41p a 74% rise, but pump prices excluding VAT only rose 32p, meaning retailers took a hit to their profit margin. So as oil and diesel prices fall, retailers are taking the opportunity to restore more normal profit margins. This is why prices will be sticky above pre-war levels. This graphs shows the gap between diesel and petrol. When there is a crisis, diesel prices tend to be more volatile because supply is more limited. April was a record gap of 34p, but even that masked some of the difference in wholesale prices.
The reason diesel matters is that demand is essential for logistics. Supermarkets and companies need to keep supplies going so they have to pay whatever the price is. Even if you don’t drive a diesel car, your shopping basket is heavily influenced by diesel prices. UK logistics consumer 17-18 billion litres diesel a year, so every 10p rise is roughly £1.8bn on haulage costs, pushing up the price of essentials.
What Happens Next?
The question for motorists, is what happens next? Will oil prices remain sufficiently low and stable for prices to keep falling or do the underlying frictions in the oil market mean prices are set to rise. One very important factor is that the perceived calm of oil markets was largely achieved by China drastically cutting imports, but now China is coming back. Although its reserves are greater than the US, it won’t want to keep running down. The concern is that if China actively restocks, it could push demand much higher, and any increase in demand will hit oil products much harder than crude because the bottleneck is in refining and shipping not crude oil.
So are we likely to see diesel of £2? Well this scenario is possible under these conditions. Hormuz remains closed because of failure to find a political solution. And then there could be more disruptions to supply from Russia, and Bab el-Mandeb. Now the thing is with onshore inventories exhausted, prices have become more volatile, because you have only one factor left to deal with supply shortages- prices rising high enough to discourage demand.
In the long-term, there are also many conflicting forces affecting oil markets, which make it difficult to predict. On the one hand, you have analysts who claim, prices will remain low. They point to electrification of vehicles, long-term weakness in demand and, supply increasing in places like Brazil, Canada and the US. However, this long-term view of an oil glut is not shared by all oil analysts. Oil supply is prone to booms and bust in investment. Between 2011-and 2014, high oil prices led to shale boom. But, after prices fell, companies cut back on investment, rather than drilling aggressively, companies returned billions to shareholders. The result is that there are many oil fields with declining capacity, and you can see the number of oil discoveries has shrunk in recent years.
Now this level of under-investment is disputed. But, at least for 2026, there is limited chance for oil companies to massively increase supply in response to the levels of supply disruption seen in the gulf area. At the very least, it is likely diesel prices will remain elevated above pre-war levels, but now with inventories falling, a continued stalemate in the gulf, could see oil and diesel prices rise quickly. This is a real headache for governments, especially with borrowing costs rising around the world, the latest video explained why this matters.
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