“Let the good work go on. We must ever remember we are refining oil for the poor man and he must have it cheap and good.”
– John D. Rockefeller
Hard Knocks
One of the more enticing things about financial markets is not that they’re predictable. Or that they’re not predictable. It’s that they’re almost predictable – or at least they appear they should be.
When the Strait of Hormuz was first closed following the ill-advised military strikes on Iran by the United States and Israel at the end of February, it was all so obvious. Oil prices would skyrocket.
With 20 percent of global petroleum liquids abruptly taken offline, the price of oil had nowhere to go but up. Simple minded speculators went all in on oil ETFs like the United States Brent Oil Fund (BNO). Some also bought call options and then counted their chickens before they hatched, purchasing first class tickets to Maui.
Those who were quick to act were able to buy shares of BNO on March 2, for $37. As of August 20, these shares were trading for $53 – up 43 percent. But after peaking on May 4, at $60, BNO is now down 11 percent.
Similarly, the price of a barrel of Brent Crude went for about $78 a barrel on March 2. It then spiked to an interim peak of $114 on May 4. As of August 20, a barrel of Brent Crude goes for $93.
What gives? Wasn’t the world running out of oil? Wasn’t a price spike above $200 a barrel imminent?
Perhaps. But there’s a risky assumption buried in those questions. Namely, that an oil crisis is a static event.
It isn’t.
Here at the Economic Prism, we put our pants on one leg at a time. We sing with our heroes at 33 and one-third revolutions per minute. And we sometimes sell shares for less than we bought them – it goes with the territory when placing asymmetric bets.
Moreover, when the answers we receive come courtesy of the school of hard knocks we want to know why. More importantly, we want to know if yesterday’s answer will still be correct tomorrow.
Useless
In early August, the Energy Information Administration (EIA) reported a massive 17.4-million-barrel U.S. crude inventory build. At the same time, the domestic supply of refined fuels has tightened dramatically, and retail prices have resumed their climb at the gas pump.
This is more than a curious market anomaly. It is evidence of severe refinery and logistics bottlenecks at work. But it is also a snapshot. That distinction matters.
The mainstream financial analysis of this phenomenon has been lacking. The media sees a massive inventory build and instantly claims global oversupply. Algorithmic traders dump crude oil futures, and retail investors who bought unrefined crude exposure like BNO are left disappointed and confused.
Yet those 17.4 million barrels did not magically appear. Oil moves through time as well as space.
Tankers loaded in the Middle East weeks earlier arrive today. Cargoes released during a temporary opening of the Strait of Hormuz may not reach their ultimate destination until long after the agreement that released them has fallen apart. Ships already on the water receive new bids. Cargoes change destinations. Strategic reserves are released. Refiners scramble for suitable feedstocks.
Thus, a massive inventory buildup in early August can reflect decisions and physical movements initiated many weeks before. This is one of the major complications of the present oil crisis.
Blockade. Truce. Restock. Blockade. Each turn of the wheel sends another pulse through a petroleum system that requires weeks or months to respond.
When it comes down to it, crude oil, like atomic bomb blueprints in the hands of Napoleon, is completely useless to a consumer. You cannot pour a raw barrel of West Texas Intermediate crude directly into an eighteen-wheeler, a commercial jet, or a lawnmower.
Raw crude is nothing more than unrefined feedstock until it moves through a complex chemical processing facility.
The entire global energy architecture relies on a continuous, uninterrupted river flowing from the wellhead to the shipping hub, onto ocean tankers, through receiving terminals, into complex refinery units, and out through pipelines to local fuel racks.
When you start blowing up refineries, damaging maritime transit hubs, attacking tankers, and knocking out critical logistics nodes along that chain, the river does not simply stop. It backs up in some places. It runs dry in others.
And every time there’s an agreement promising safe passage, the backed-up portion surges forward again. This is why the location of the bottleneck matters more than the headline price of oil.
Upstream of a bottleneck, unrefined oil may have nowhere to go. It backs up into storage tanks, builds up in regional hubs, and creates a localized glut that suppresses the spot price of raw crude.
Downstream of the bottleneck, the market can simultaneously starve for usable products. Gasoline, ultra-low sulfur diesel, and jet fuel become scarce, driving consumer prices significantly higher.
But this relationship is not permanent. Remove the bottleneck – or move it – and the pricing structure can reverse with remarkable speed.
Crack Spread
This widening divergence between the price of raw crude oil and the price of refined fuels is captured by a key industry metric known in energy trading circles as the crack spread. In simple terms, the crack spread represents the gross refining margin between crude oil and the refined products made from it.
The classic benchmark is the 3-2-1 crack spread, which models the expected yield of taking three barrels of crude oil and processing them into two barrels of gasoline and one barrel of distillate fuel like diesel or heating oil.
Crack spreads move around even during ordinary times. Driving season, heating demand, refinery maintenance, product specifications, inventories, crude prices, and unexpected outages all have their influence.
What normally prevents extreme spreads from persisting is competition and arbitrage. If refined product prices spike, operating refineries have an incentive to run harder. Refined product may also be imported from other regions. Crude flows toward the plants offering the best economics. Eventually the market returns the spread back toward its normal range.
Right now, that market balancing mechanism is impaired. Physical refinery infrastructure has been damaged. Shipping routes are contested. Tankers take long detours or wait for temporary transit windows. Some crude grades are stranded where refiners cannot reliably obtain them. Other crude grades command extraordinary premiums simply because they can be delivered.
You can have an absolute ocean of crude sitting at the wellhead, in storage tanks, or floating offshore, but if the right crude cannot reach the right refinery – or the refinery capable of processing it is damaged – the finished product remains scarce.
The crack spread then blows out.
Just this week, for example, the U.S. diesel crack spread exceeded $100 per barrel for the first time in history, reaching an intraday record on Monday of $102.20, while U.S. distillate inventories are at their lowest August level since 1996. Moreover, global refinery throughput in July was about 5 million barrels per day below a year earlier.
According to Vortexa data, diesel and gasoil exports from the Middle East and Russia have crashed by more than 50 percent year over year. As a result, prices have spiked, with the average U.S. diesel price at $5.47 per gallon, which is more than 40 percent higher from one year ago.
This structural bottleneck creates the seemingly insane scenario many investors remain oblivious to. Crude oil could conceivably fall to $40 a barrel while standard grade gasoline spikes above $10 a gallon and commercial diesel skyrockets above $20 a gallon.
But there’s also the possibility that crude could spike up above $200 a barrel.
These outcomes sound contradictory. They are not. They merely require the bottleneck to be in a different place.
Moving Target
This is where the current petroleum situation becomes much more interesting than the simple refinery-bottleneck storyline.
Remember, the oil system is dynamic. Imagine the Strait of Hormuz closes. Crude production continues for a time, but export tanks fill. Tankers wait. Producers discount stranded barrels. Refiners outside the Persian Gulf scramble for substitutes. Brent rises. Alternative crude grades command premiums.
Then comes an agreement. A memorandum. A ceasefire. A temporary shipping arrangement. Call it whatever the diplomats like. The stranded crude begins moving.
Hundreds of millions of barrels accumulated behind the bottleneck can suddenly enter the transportation system. Tankers scatter across the oceans chasing the highest bids. Some head east. Others head west. Still others change destinations while already underway.
Weeks later those barrels begin arriving. Commercial crude inventories jump. Media headlines declare an oil glut. Crude prices fall.
Yet the refinery system may still be damaged. Diesel inventories may still be depleted. Gasoline may still be scarce. The ships may have delivered crude faster than refineries can convert it into useful products.
This is where we appeared to be in early August when the EIA reported the 17.4-million-barrel U.S. crude inventory build. However, this picture has quickly changed. The Trump administration said oil traffic through Hormuz was back to normal. This was a lie. Once again, the Strait is closed. Now things get interesting.
The barrels accumulated during the previous blockade have already been released. Destination inventories have only partially recovered. Refiners have been running hard. Strategic petroleum reserves have been drawn down. Tankers are scattered across unfamiliar routes.
The latest blockade began from a different starting point. The details are fuzzy. Perhaps there are fewer stranded barrels available for the next reopening. Perhaps there is less crude already on the water. Perhaps consumer inventories are lower. Perhaps another refinery has been damaged. Perhaps a bypass pipeline or export terminal has been attacked.
The same blockade that produced $114 Brent the first time may produce an entirely different price this time around. Markets have memories. Storage tanks have capacities. Neither is infinite.
Stuck at the Wellhead
To the average consumer, pulling up to a gas station pump and paying $10 a gallon signals an oil crisis. They read the headlines, and reports of rising oil reserves, and assume energy companies involved in extraction are making absurd profits.
In reality, the producer sitting at the wellhead might be selling their crude at a massive discount simply because the local pipeline network is choked, the export route is closed, or nearby refineries are destroyed or operating at reduced capacity.
The producer is trapped with raw product it cannot ship, while the consumer at the pump is paying for the extreme scarcity of the finished product. The price you pay at the pump reflects the landed, refined price of fuel at the end of a broken delivery system, not necessarily the price of oil sitting in a tank in Texas, Cushing, or the Persian Gulf.
This dynamic is further complicated by regionalism and crude grade mismatches. Refineries are not generic machines. They are custom engineered chemical plants designed around particular crude types, ranging from light sweet crude to heavy sour grades.
When global trade routes break down and tanker fleets are degraded by physical attacks, prolonged detours, insurance costs, or maritime hazards, refiners cannot simply substitute one crude source for another without consequence. A complex refinery designed around heavy sour crude cannot necessarily replace its lost feedstock barrel-for-barrel with light sweet crude and maintain the same yields and economics.
Thus, an ocean of the wrong crude may coexist with a desperate shortage of the right crude. This creates instances of oversupply in one geographic zone alongside massive fuel shortages somewhere else. And this is where traditional energy investing becomes risky.
Buying broad oil ETFs or upstream exploration companies assumes that higher gasoline or diesel scarcity translates into higher crude prices.
Sometimes it does. Sometimes the producer owns precisely the crude grade everybody suddenly needs and has secure infrastructure to get it to market. Other times the producer is sitting behind the bottleneck, watching storage tanks fill while the price of gasoline explodes somewhere else.
The useful distinction is not upstream versus downstream. It is something more basic: Who controls the scarce function?
Today the scarce function appears to be conversion. An intact complex refinery with reliable feedstock and access to high-demand product markets is an extraordinary asset. It can buy discounted crude or other suitable feedstocks, run them through operational processing units, and sell gasoline and diesel into markets paying historic markups.
The widening crack spread can translate into eye-popping margins even while headlines talk about falling oil prices.
But tomorrow the scarce function could be transportation. A tanker fleet able to move crude around a closed chokepoint suddenly becomes the tollbooth.
Or the scarce function could be storage. Or a pipeline connecting stranded heavy crude to an operating refinery. Or an export terminal outside missile range. Or simply a producer holding the correct crude grade on the correct side of the blockade.
This is why the petroleum system cannot be traded as one uniform asset. The money collects at the bottleneck. And the bottleneck moves.
Beyond Crude
The primary beneficiary in the present environment is the refining sector, specifically companies with geographically insulated, complex refining capacity. Facilities that remain fully operational, secure from physical conflict, located close to reliable crude sources, and connected to high-demand product markets are holding an enviable tollbooth.
Secondary opportunities exist along the midstream and specialized logistics chain. When traditional shipping lanes and pipeline networks are disrupted, the flow of energy does not necessarily stop. It simply takes longer, travels farther, becomes less reliable, and costs more.
Companies that own critical storage assets at key ocean hubs, specialized product pipelines that bypass damaged regional nodes, or modern tanker fleets capable of navigating disrupted trade routes can command substantial pricing power.
Every extra day a vessel spends taking a long detour around a blocked transit corridor removes effective shipping capacity from the global market, driving up charter rates for the surviving fleet. Yet investors should be careful not to confuse the present bottleneck with a permanent one.
A refinery bottleneck can suppress crude prices. A transportation bottleneck can send them soaring. And a renewed blockade occurring after inventories have already been drained can transform yesterday’s crude glut into tomorrow’s crude panic.
That is how $40 crude and $200 crude can both belong to the same crisis. Just not at the same time.
Disruptions and resumptions along the petroleum supply chain act like pulses. A blockade causes crude to back up. A truce results in crude pouring out. Weeks later, inventories jump.
Then, there’s another blockade and the cycle starts over. Except the system is now starting from a different inventory level, with different refinery capacity, different tanker positions, and different available buffers.
Therefore, a temporary reopening of the Strait can create the appearance of abundance without restoring the system that created abundance in the first place. This is why crude inventory builds following a truce should not automatically be interpreted as proof that the crisis has ended. They may instead represent the delayed arrival of barrels released during the previous opening. Likewise, a ceasefire or memorandum should not be confused with normalization.
A functioning petroleum system requires repeated commercial voyages, available insurance, functioning terminals, reliable refinery operations, adequate inventories, and enough confidence that a tanker entering a chokepoint today can reasonably expect to exit tomorrow. A peace agreement can open a shipping window. It cannot instantly rebuild the system.
Follow the Molecule
So, could oil still reach $200 a barrel?
Certainly. But not simply because 20 percent of the world’s oil goes through Hormuz. That was the easy trade.
The harder question is what condition the petroleum system is in when the next serious interruption arrives.
If crude inventories have rebuilt, strategic reserves remain available, tankers are positioned correctly, alternative exports are flowing, and demand has been destroyed, another blockade may produce surprisingly little crude-price appreciation.
But if the latest closure is now coming after the movable crude accumulated during previous blockades has already been released, destination inventories remain depleted, strategic stocks have been drawn down, alternative routes are constrained, and another piece of refining or export infrastructure has been destroyed, the market could discover very quickly that yesterday’s crude surplus was temporary.
Then the bottleneck migrates upstream. The crude that was useless yesterday becomes desperately valuable tomorrow. Brent may not stop at $114 merely because that’s where it stopped last time.
Investors must completely separate the price of raw crude from the price of refined fuel. But they must go one step further. They must separate crude by grade, geography, transportation route, refinery compatibility, and time.
The market is no longer operating as a smoothly connected global petroleum pool. It is increasingly operating as a collection of regional pools joined together by damaged, expensive, and periodically unavailable infrastructure.
This creates extraordinary price contradictions. Crude inventories can rise while diesel becomes scarcer. A producer can sell oil at a discount while a refinery pays a premium for another grade. Brent can fall while crack spreads rise. Then one tanker attack, refinery outage, pipeline failure, or collapsed truce can rearrange the entire hierarchy.
Those who continue to trade the oil sector as a single uniform asset will repeatedly find themselves on the wrong side of the bottleneck.
The better approach is to follow the actual physical flow. From the wellhead. To storage. To the tanker. Through the chokepoint. Into the refinery. Out the product pipeline. And finally, to the rack.
Then ask one question: Where does the flow stop?
Last week, the answer appeared to be refinery conversion, correct feedstock, and secure logistics. Today, it appears that crude itself can be added back into the picture.
The greatest opportunity – and the greatest risk – is not that the bottleneck exists. It is that the bottleneck moves. How to capitalize on changing dislocations in the physical flow is the task at hand.
[Editor’s note: Get a free copy of an important special report called, “Fission for Millions – The Ultimate Bet on the AI Energy Crisis,” when you join the Economic Prism mailing list today. If you want a special trial deal to check out MN Gordon’s Wealth Prism Letter, you can grab that here.]
Sincerely,
MN Gordon
for Economic Prism
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