This morning I woke up, and once again I read about President Donald Trump saying he will refill the US SPR with Crude Oil from Venezuela. I won’t be surprised if anyone in the oil industry takes a shot of Tequila every time he says that. Why? Because the US can only store Light and Medium-Sour crude in its salt cavern system. Even the intern knows that. But in the golden age of propaganda and opinions constantly winning against fact, you can claim anything you want, and as long as enough people believe it, it’s considered truth. This is a great strategy, especially to gain electoral consensus, but sooner or later reality bites you in the ass. This is exactly what’s happening right now with the Diesel crisis.
My followers know I was among the first (I cannot claim to be the first since there might have been someone else in the corner of social media warning about it ahead of me) to warn about the inevitable Diesel crisis that was going to hit the economy very hard. Here is what I wrote specifically on the 15th of June in one of my favorite warnings on the matter:
“This is how the oil crisis was postponed, not avoided. Furthermore what’s coming is going to be even worse since now most of the buffer (SPR + Commercial reserves) is gone – it will not take months, but years to reestablish
Enjoy your last days of affordable gasoline and diesel”
At that time, every popular “expert” on crude oil was instead claiming the very opposite and that we were in an “Oil Glut”. No need to say anything more on this ridiculous matter since today everyone agrees that was complete nonsense. However, a few months ago there were not many people like myself who dared to argue against that nonsense; after all, crude oil and diesel prices were crashing. Hilariously, the day I said “Enjoy your last days of affordable gasoline and diesel,” it was the exact market bottom, and from there prices started to race higher without ever looking back.
I am a numbers guy, and like all of those who grew up in the Fixed Income space, we tend to look at two things all the time: if something makes sense and if reality and assumptions match. Because in the Fixed Income business, your returns are capped, while you can always lose 100% of your capital, when you analyze the Macro and credit components that matter in your decisions, either to make money off a trade you broker or a risk you will have to manage, it is key to cut through the noise, see the reality as it is, and make sure the likelihood of the asset defaulting in its lifetime is minimal. This then creates the distinction between credit analysts and equity analysts, but also between Macro analysts and commodity analysts. One cohort lives by assumptions about the future, the other by facts about the present. I live in the present, because one of the first lessons I learned when I stepped onto a trading floor was that “assumptions are mothers of all fuck ups”.
I am not a petrochemical engineer, nor have I ever traded commodity cargoes, but I am a numbers guy aware of his ignorance at all times; that’s why I never take a narrative for granted or whatever anybody says, and I always dig into the numbers myself, making sure I understand what those numbers mean. This is how I got the Diesel problem right from the very beginning, like many other things in other areas of the market; I consistently anticipated in advance through the years before the whole crowd figured that out, often forced by reality going against popular assumptions.
First of all, as I tried to make people understand for months, ultimately posting a graphic on the 19th of July, CRUDE OIL IS NOT THE SAME AROUND THE WORLD.
After months of being in this mess, I still hardly see any “expert” highlighting this very simple fact, and the vast majority continues to talk about crude oil as if it is all the same. Because crude oil is not the same, Diesel is not refined using the same crude oil blends across the world. Yes, DIESEL IS NOT THE SAME AROUND THE WORLD, as you can see in the map below that Grok gently assisted me in quickly putting together.
There is a third element important to consider before putting all the pieces of this puzzle together, and that is refining capacity in every region of the world. As you can see in the chart below, in some regions more product is refined compared to local consumption; in others is the opposite.
Now let’s put it all together, shall we?
- US has the refining capacity to serve its domestic market and a surplus, but it does not produce the crude oil its refineries need. The reason why the US exports the surplus of light crude it does not need and imports the sour crude oil it needs. Yes, THE US IS NOT ENERGY INDEPENDENT.
- Because the US had surplus refining capacity, like all the world, before the war in the Middle East started earlier this year, the loss of product output from the Middle East was compensated by all other countries gearing up their refinery production. Some even ran above 100% capacity to make as much money as possible before prices crashed again, assuming the war would not have lasted too long. The reason why you saw many refineries blowing up across the globe.
- It is true that a few months ago Ukraine started blowing up a considerable amount of oil refineries in Russia, ultimately triggering a Diesel crisis in one of the most oil-rich countries in the world, but as you can see from the chart below, even assuming the whole Middle East and Russia refinery system goes offline, all the rest still has spare capacity to absorb it. Not surprisingly, Russia quickly agreed on oil swaps with India and China, agreeing to supply Urals crude oil in exchange for diesel.
Of course, tightness in the refineries’ capacity across the world has been a factor in pushing diesel and other product prices higher, but that has been far from being the main reason, unlike what many Western governments across the world decided to conveniently claim.
Shipping costs are definitely an important factor as well, and the reason is very simple: now both the Strait of Hormuz and the Bab el-Mandeb Strait traffic is heavily disrupted, on top of a growing number of oil tankers being hit and disabled every single day, with all the indirect consequences related to this (like insurers unwilling to write coverage on cargo in war zones), shipping costs to deliver crude oil from a specific area to another have skyrocketed. However, shipping costs did not jump everywhere in the world, but specifically towards Asia that was the major importer of crude oil from the Middle East.
As a matter of fact, the US should have been immune from all of this considering the proximity of the crude oil it needs to import and the ample refining capacity to serve its domestic market, right? In practice, in an open market, both Canada and Mexico, the major suppliers of sour crude to the US, started selling cargoes to Asia, in particular Japan and India. As a consequence, crude oil prices started to rise despite the artificial glut created at the very beginning thanks to huge SPR dumps in the US, Japan, and Europe. At this point, I believe you all understand how the rising Diesel prices in the US are a factor of crude oil supply problems, NOT REFINERY throughput.
Here it comes Europe that, of course, thanks to its dysfunctional administration, managed to get itself into BOTH a refinery and crude oil shortage crisis AT THE SAME TIME. Because of absurd “green” policies, Europe not only did not build enough oil refinery capacity to serve its domestic market, but, with the Middle East capacity going offline, was forced to rely on the US for obvious geographical proximity. Not surprisingly, the excess capacity in the US compensated for the scarcity in Europe for all these months.
At this point, it should be easier to understand why a US export ban won’t lower Diesel prices in the US; they will eventually continue to rise due to increasing crude oil input costs, but refineries will cut their throughput to avoid unnecessary excess fuel production. On the other side, the same export ban will create a MASSIVE problem for Europe which will have to compensate for the missing Diesel supply with its own SPR. Here is another big difference between the US and Europe. Because the US has enough refinery capacity to serve its domestic market, storing crude oil only in the SPR would have buffered its problems if the SPR were not used to artificially suppress crude oil prices, subsidizing the cost of a barrel for the whole world. On the other hand, because Europe does not have enough refinery capacity, part of its SPR is held in products like Diesel. Releasing Diesel SPR in Europe also has a big bottleneck, and that’s the distribution system, ultimately making Europe unable to release more Diesel than what its domestic market consumes. Consumption will also rise significantly into the cold winter months. It does not take a genius to figure out that in a few months the European economy will run out of the Diesel “blood” to operate in a few months and grind to a complete halt. Especially when India and China already stopped Diesel exports to protect their local economies and took supply out of the global market.
What do you expect is going to be the impact on crude oil prices when you create an acute scarcity of product and commercial inventories are already at multi-decade lows because nobody refilled crude oil, assuming the supply disruption would not have been long-lasting? There will be a rush to secure crude oil supply, and that will be sold to the highest bidder since no country, including the US, can ban crude oil exports, triggering similar retaliation by trading partners, since NOBODY produces all the types of crude oil it needs to be truly energy independent. The rush to secure crude oil supply sold to the highest bidder will inevitably create a crisis in all those countries that cannot afford to pay prices above a certain level or that have no crude oil production at all. India and Japan, among the developed countries, will be the most exposed to this economic threat, as I explained in this analysis I shared several weeks ago with my premium subscribers: “A GUIDE ON HOW TO UNDERSTAND THE IMPACT OF RISING CRUDE OIL PRICES ON NON-USD CURRENCIES”
To conclude, there is only one solution to stop this dangerous spiral and put an end to all this mess: end the war against Iran and its proxies like the Houthis in Yemen. Here, President Donald Trump has two alternatives: either find a compromise that will be very unfavorable to the US in the current circumstances or pursue a second big military escalation, hoping that will be successful in breaking Iran’s willingness to endure a conflict and continue disrupting the flow of crude oil in the Middle East. Something that, despite all the fake data and propaganda disseminated in the past week, Iran is still successfully doing otherwise, similar to the previous “glut” frenzy that was more created by SPR releases and not by flows recovery; if this “Hormuz glut” were real, crude oil prices would have crushed again all the way back to ~60$. However, the SPR buffer is gone; hence, this second attempt to sell a “glut” narrative, which, for those who look closely, makes no sense whatsoever, as I flagged many times on X, would have had a much different impact on markets, not limited to crude oil futures price manipulation.
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