What if a diplomatic breakthrough between Washington and Tehran permanently reopens the Strait of Hormuz? While that would likely lead to a plunge in crude prices, it probably would not deliver quick relief in the refined product market.
That’s because more than 20 refineries across the Gulf suffered damage during the war, many of which will require extensive repairs. Lead times for crucial equipment — including compressors, heat exchangers and specialised catalysts — were already stretched before the conflict began, making a speedy recovery implausible.
China's response to the tightening supplies will also be critical. The world's second-largest refiner sharply reduced its processing rates and curtailed fuel exports during the war.
Demand destruction could prove more significant than currently projected as consumers and businesses pull back on spending in the face of eye-watering energy bills.
But the urgent need to replenish – and in some cases expand – global fuel inventories should add upward pressure to refining demand, potentially for years.
This dynamic raises the prospect of a sustained bout of energy-driven inflation this winter and beyond.
Recent inflation data is already pointing in that direction.
U.S. consumer prices rose 3.4% in July from a year earlier, driven in large part by a 14.7% increase in energy costs, including a 24.6% jump in gasoline prices. Euro-zone inflation accelerated to 2.9%, led by a 10% rise in energy costs, while Japan’s producer price index rose 7.2% in July.
Many Wall Street analysts and economists still assume the energy price spike will be a short-term phenomenon unlikely to feed through to core inflation. But if the refined product crisis is as serious as current data suggests, that assumption may be too optimistic.
This is especially true in Europe and Asia, where liquefied natural gas prices have also spiked. The U.S. has not been immune to rising energy prices, and the risk to current projections through year-end is clearly tilted to the upside.
U.S. President Donald Trump, who has made lowering the cost of living a central pillar of his second term, has seemingly acknowledged this, warning Americans last week to prepare for higher energy prices.
Nearly six months into the Iran war, the world appears to be witnessing a slow-motion crash. The fuel market’s safety buffer has been stripped away as inventories have been depleted, while disruptions caused by the war continue to strain the overstressed refining system.
The energy crisis that really matters to the global economy is just getting started.
XLE•
