Fuel Shocks Are An Even Bigger Threat To Risk Assets Than Crude

Authored by Michael Ball, Bloomberg macro strategist,

Risk assets face a harsher stagflation shock now that energy infrastructure is being targeted in the Iran war.

That means crude needs a bigger risk premium. 

But the real pain will increasingly be in products, where diesel, jet fuel and other distillates are rising faster than oil and weighing more heavily on growth-sensitive assets.

This is no longer only a logistics story.

Once fields, ports and refineries are in danger, the market stops treating this as a temporary shipping bottleneck and starts pricing a broader supply shock.

Goldman Sachs energy research team see three main channels through which the conflict in the Middle East reduces supply of refined products.

#1. Hit to Persian Gulf's ability to export refined products.

The Persian Gulf accounts for 3.3mb/d of refined products exports (13% of global flows), with nearly all of the products exports typically passing through the Strait of Hormuz.

Refined naphtha (used for petrochemical feedstock) and middle distillates (diesel and jet fuel) each account for about 1/3 of Persian Gulf refined products exports, while 2.0mb/d (nearly 60%) of the refined products exports from the region go to Asia.

Nearly 50% of Asia naphtha imports and 40% of European jet fuel imports come from the Persian Gulf .

However, Europe had over two months of middle distillate stocks (including SPR) in days-of-demand covered before the war, which should provide some near-term buffer.

#2. Higher Middle East refinery outages.

We estimate that refinery outages in the Middle East increased to 2.2mb/d on both physical damages (Bahrain's Sitra refinery) and precautionary shutdowns (the UAE's Ruwais refinery).

The IEA estimates that over 4mb/d of refining capacity in the Middle East is currently at risk.

Some export-oriented refineries in the region (including Kuwait's Al-Zour) have reportedly already slowed crude runs as storage approaches capacity.

Iran’s threat to retaliate by striking Gulf neighbors’ energy assets after its offshore natural gas fields were attacked Wednesday morning is a clear escalation and new phase in the current conflict.

#3. Hit to crude inputs into global production of refined products.

Persian Gulf typically exports nearly 15mb/d of crude via the Strait of Hormuz, including 12.8mb/d to Asia refineries or nearly ½ of total Asia crude imports.

Nearly 60% of typical crude exports from the Persian Gulf are medium and heavy crude (typically used to produce jet fuel, diesel, and fuel oil) with much more limited alternative producers outside the Middle East vs. light crude (e.g. US shale).

Moreover, the two main crude redirection pipelines around the Strait of Hormuz -- East-West and ADNOC -- primarily export light crude, which flows more easily.

As a result, the 5.0mb/d decline in global exports of medium and heavy crude year-to-date (vs. a 1.7mb/d increase in light crude exports) is disproportionately weighing on global production of middle distillates and fuel oil.

Read Goldman's full note: "Even Larger Shock for Refined products Than for Crude" here...

The real economic hit comes through the rise in product prices.

Diesel above $5 a gallon in the US is the clearest warning because it runs through trucking, construction and industrial margins fast.

Jet fuel, gasoil, fuel oil and naphtha are under even more pressure, especially in Asia.

Average Global Jet Fuel Prices Rallied by $74/bbl Since the Start of Iran War -- More Than Double of the Average Crude Price Boost

Gulf barrels skew sour and often medium, with a meaningful heavy component - feedstock that many Asian refiners are built to upgrade into diesel and other products.

Lose those barrels and the global crude slate gets lighter and less well matched to much of the refining system.

h/t David Doherty

The market structure is validating it.

Heating-oil, gasoline and 3-2-1 crack spreads are all trading at multi-year highs, and product timespreads remain steeply backwardated.

WTI is lagging Brent because reserve releases and export limits means spot tightness in the US will be more limited than on the global stage.