Analysis: U.S. Refiner Margins May Soar Amid Mideast War

VIENNA (DTN) — Higher margins may be in order for U.S. refiners as a pause in the Middle East’s oil supply artery leaves oil and product prices with their largest one-day jump since the Russian invasion of Ukraine four years ago.

U.S. refiners don’t just run crude; they buy secondary feedstocks like Vacuum Gas Oil (VGO) to feed their crackers. Much of the world’s merchant VGO comes from the Middle East.

Prolonged crude supply outages may force U.S. refiners to source part of their diet elsewhere, but the ongoing situation also means higher margins. The world’s middle distillate supply, already relatively tight, may be equally as affected by the war as crude.

The Middle East’s supply constraints extend far beyond the 3.2 million bpd of crude and condensate Iran produces. While OPEC sits on enough spare capacity to compensate for Iranian oil, most must still transit the Strait of Hormuz.

Following Iranian attacks on ships, tanker traffic through the Strait has ceased almost entirely. This narrow waterway is the largest chokepoint for global oil flows, handling 15 million bpd of crude and 5 million bpd of petroleum products.

Saudi Arabia alone produces some 2.7 million bpd of refined products, including 1.2 million bpd of diesel, exports of which rely heavily on the strait.

Pause of activity on the waterway effectively starves U.S. Gulf Coast (USGC) secondary units of the intermediate feedstocks needed to maximize gasoline and diesel yields.

Expanding Margins

Fuel prices surged alongside crude in response to the crisis, propelling refining margins higher. Consequently, the 3:2:1 crack spread used by U.S. refiners surpassed the 18-month highs reached in November when diesel prices rallied globally.

Refined product supply was further jeopardized by an Iranian drone attack on Sunday. The strike forced shut operations at Ras Tanura, Saudi Arabia’s largest refinery and a main diesel supplier to Europe.

U.S. refiners are in prime position to fill part of this gap, but current physical capacity constraints limit that potential. March is a peak period for planned refinery turnarounds as plants transition to summer-grade gasoline.

The price spike is hitting exactly when several major USGC plants are offline for maintenance. This seasonal downtime restricts the ability of domestic refiners to immediately increase throughput to meet the global shortfall.

While domestic dependence on Middle Eastern crude has waned, the U.S. still imports more than 500,000 bpd from the region. Heavy-sour crude from Canada and Venezuela can step in to replace grades like Arab Heavy.

Lighter grades are not in short supply given record domestic production and projects in Guyana and the North Sea. However, East Coast refiners may face higher freight costs to secure these alternative supplies.

Furthermore, the Jones Act limits the flexibility of moving USGC light sweet crude to Northeast refineries to replace Mideast imports. This regulatory hurdle complicates the domestic effort to balance internal demand during the crisis.

The duration of oil supply outages will determine if the current price action is a temporary spike or the harbinger of $100 bbl oil. Additional risk to diesel supply could easily propel margins past the multi-year record highs.