Why Isn’t the Price of Oil Even Higher?

Donald Trump is not a well man. He is, unfortunately, also President, which means that we all pay a price for his inability to accept reality. Notably, while he insists that he has “total control over the Strait of Hormuz,” shipments of oil through the Strait will remain minimal unless Trump can find a way to smuggle oil out in catering carts — or until he makes a deal with Iran. And we won’t have such a deal until he faces up to the reality that he lost his war of choice.

The Hormuz closure means, in turn, that oil prices — which briefly fell most of the way back to prewar levels on hopes that a deal was really coming — will remain high for the foreseeable future. Here’s the price of Brent crude:

But here’s the puzzle: Why aren’t oil prices even higher? They were over $100 a barrel before markets began betting on an end to the war, so why aren’t they back above $100 again? Also, why are they “only” about $25 a barrel above prewar levels, when many analysts — myself included — suggested that they might go much higher?

A large part of the answer is that oil prices actually are higher — if you look at the right numbers.

Today’s post will be short and wonkish, because I’ve been overwhelmed with real-life responsibilities. I have had enough time, however, to put together a few charts.

So, what do I mean by looking at the right numbers? Nobody burns crude oil directly. Instead, they burn products refined from crude, mainly gasoline and diesel. And these prices, after falling for a while on fake news of peace, are back most of the way to their recent peaks. Here, for example, are wholesale diesel prices:

Source: Haver Analytics

The difference between the price of a barrel of crude and the price of the products refined from that barrel — the “crack spread” — has exploded, rising about $35/barrel since the eve of the war:

Source: RBN Energy

So while the price of a barrel of crude is up around $25, the price of the products refined from that barrel is up about 25+35=60 dollars per barrel, putting it in the range of middle of the road predictions of what would happen as a result of a long-term Hormuz closure.

Why has the crack spread widened so much? The main answer is that a lot of the world’s refining capacity is either trapped inside the Strait or offline as a result of Ukraine’s drone campaign against Vladimir Putin. So it’s not all about Iran. Indeed, one indicator of how much the other war matters is that JD Vance reportedly had to plead with Volodymyr Zelenskyy to halt attacks on oil tankers using the Russian port of Novorossiysk.

The shortage of refining capacity has, in turn, held crude prices down: Buyers aren’t willing to pay extremely high prices for crude oil they can’t refine. Or to put it a different but equivalent way, the cutoff of oil shipments through the Strait of Hormuz in effect required a large rise in global oil prices to ration demand, but much of that rationing has taken place through a rise in the crack spread rather than a rise in crude oil prices.

What does all this mean for the United States? Most immediately, inflation — which was held down for the last two months by falling fuel prices — is set to rise again in next month’s data. And everyone can see that gasoline is back above $4 and diesel back above $5.

So those obsessed with the midterm elections — which means everyone who is paying attention to the crisis of American democracy — should realize that the blue line at the bottom of this chart this is unlikely to turn around significantly before November:

MUSICAL CODA

In honor of Operation Catering Truck: