The new oil crisis runs through diesel

Filling up a pickup truck with diesel right now costs about $6.50 per gallon in the United States—down a few cents from the record set in September, but still about 70% higher than in February. The most obvious explanation is the war with Iran and the crippling of the Strait of Hormuz.

It’s actually more complicated.

Crude oil was nearly $95 per barrel at publishing time, but that’s not high enough to account for the skyrocketing cost of diesel. Historically, diesel at these levels would point to crude in the $160/bbl range.¹ Another way to look at it is through crack spreads, the difference between crude prices and the price of refined products.² This measure has remained near all-time highs.

The world doesn’t consume crude but refined products

Crude oil has limited economic use until a refinery turns it into gasoline, diesel, jet fuel or other products, and the global refining system is under severe strain. Global refinery throughput is running near 78 million barrels per day (bpd) in Q2, roughly 6 million bpd below the seasonal median and almost 8 million bpd lower than a year ago.³

The shortfall is concentrated in Russia, Asia and the Middle East. Russian refinery runs have fallen to 3.3 million barrels per day, down 34% year over year, while Middle Eastern refinery throughput is below 7 million bpd, down 23% year over year..⁴ China has not been able to offset these losses; recently, Chinese suspended product exports, adding another constraint to global supply. 

At the same time, global refinery outages remain highly elevated, with industry estimates of more than 9 million barrels per day of planned and unplanned downtime, roughly 4 million barrels per day above historical norms.⁵ The result is a refining system that is struggling to respond even as product margins remain exceptionally high.

Oil is still being extracted and exported from the Middle East, but the infrastructure that turns it into a useful product and ships it is in short supply. This is visible around the world, where price signals, and government policies, highlight the shortage of refining capacity. Restoring global supply of refined product is not as simple as reopening the Strait of Hormuz.

Refinery capacity has been physically destroyed in Ukraine and Russia as a result of the war, and the Middle East conflict has also damaged regional refining infrastructure around the Persian Gulf. This has compounded to strain a sector that was already running at or near max capacity following years of under-investment and global refinery closures.

Global fragmentation—visible in an increased number of conflicts and a focus on energy security—has created a very tight market unable to respond to shocks. A normalization of flows through the Strait of Hormuz would undoubtedly help, but volatility in refined products could persist for some time.

Diesel matters: How high diesel prices impact the economy

Higher refined fuel prices have a direct impact on growth and inflation.

That’s because gasoline is mostly a consumer product. When its price rises, households have less to spend. Diesel, however, is mostly a business input: It moves freight, runs construction equipment and powers tractors, combines and garbage trucks. Almost everything consumers buy has diesel embedded in its price several times over.

A sustained diesel shock raises the cost of producing and delivering nearly everything, pushing up the price of goods with no obvious connection to energy, with huge potential impacts on the economy. Our “line in the sand” when it comes to hurting economic growth is not a precise threshold, but rather a practical guidepost: sustained national average diesel above $10/gallon.

J.P. Morgan Private Bank estimates suggest a diesel price per gallon of $10, versus the historical average of $3–$4/gallon, could cut U.S. growth in 2027 to roughly 0%–0.5%, from a baseline of 1.5%–2.0%. That level could also send core inflation to around 3.0%–3.2%. That kind of slowdown is consistent with unemployment rising by half a percentage point to as much as a full point.

If the price of diesel were to move into that $10 per gallon territory and remain there, we would expect U.S. economic activity to slow sharply, with a meaningful chance that recession becomes the base case. This is not because $10 is a magic number, but because diesel, at that level, would represent an extreme and persistent production-cost shock to the industrial sector.

Such a slowdown would also create a difficult backdrop for the Federal Reserve. A normal recession lets the Fed cut rates. This would arrive as a growth shock and an inflation shock at once. We think the Fed would respond in the traditional way of cutting rates, but with inflation already above trend, the decision would not be clear-cut.

What if the closed Strait is a new normal?

It’s natural to ask, in the event a closed Strait of Hormuz became a long-term reality, why not simply work around the Strait? The answer is that bypass routes exist and they are being used, but they trade one problem for another. Oil leaving the other coast of Saudi Arabia, on the Red Sea, must pass through Bab el-Mandeb, where Houthi forces, considered Iranian proxies, have attacked ships—at an escalating pace in recent weeks—leaving ship-to-ship transfers of the coast of Oman as the best option.

The spate of recent missile attacks on Saudi Arabia highlights the fragile security environment. Further escalation, particularly on oil and gas facilities, at a time when interceptors are running low poses a material risk to oil prices.

Pipelines themselves are also targets. The September strike by Iranian-allied forces on the East-West line⁶ was a deliberate signal that Tehran and its proxies can raise the cost of oil faster than the United States and its allies can establish new export routes around the damage. Venezuela oil production is often pointed to as a potential swing factor that can improve global supply conditions, but much of the same constraints hold and the timeline for boosting production is measured in years due to the country’s dilapidated infrastructure. Likewise regarding the recent decision to allow Russian exports of diesel, this will marginally increase global supply, but not enough to have a material impact on prices.

New pipeline capacity will reduce the chokepoint risk of the Strait but new capacity can take about two to five years depending on the complexity of the project.

How could diesel get to $10 per gallon?

Diesel prices are off their peak, so has the worst may have passed—or it may not have. Could diesel prices rise again, possibly even further? Prices at publishing time were already impacting the transportation, manufacturing and agriculture sectors, but a move much higher would slow economic activity broadly.

Mindful of that risk, what we are watching:

• Winter is the key factor. Distillate, in the same product family as diesel, heats homes across the U.S. Northeast. Government forecasters expect U.S. distillate inventories to fall below 100 million barrels, and to stay beneath their five-year low through the end of 2026 and most of 2027 Worsening the squeeze, refineries conventionally cut production for autumn maintenance as harvest and heating demand climb. A colder-than-usual winter could spark even higher demand; a mild winter could reduce the pressure.
• Refineries running at full throttle. American refiners have deferred maintenance to capture historic margins. That works until it doesn’t—recent unplanned breakdowns have already knocked out an estimated 500,000 barrels per day of capacity.
• Thin inventories. When storage levels are high, a disruption can be absorbed. When they’re near bottom, each draw moves prices more than the last. Inventories have a clear relationship with prices (see chart), and they are continuing to fall below recent-year norms (see Chart).
• Escalation. Houthi attacks on Saudi energy facilities remains a key risk. The East-West pipeline is operating at half capacity and remains a target. There is uncertainty about outlook for a Russia/Ukraine energy truce. 

Why oil could stay higher for longer

Near-term trends are posing a challenge, but our base case remains that a resolution can be achieved that reopens the Strait and eases pressure on prices. The twin blockades are creating economic pressure on both sides. In Iran, economic pressures are building through high inflation, currency depreciation and product shortages.

For the global economy, the pressure is felt primarily through higher fuel costs but also through market variables such as higher yields and equity volatility (see chart). Government actions aimed at releasing oil from strategic reserves, export controls and energy so-called “truces” highlight that the pressure is building. Ultimately, it is in the interest of both sides to find agreement and an end to the conflict.

The sticking point is that neither side will move first and surrender the leverage that got it to the table. Two earlier ceasefires, in April and June, collapsed within weeks, so the realistic expectation is not a grand settlement but something narrower and more fragile, and the possibility that it fails and the conflict escalates again.

Should that occur, the problems could compound. The Strait can reopen in days, but the damage of emptied storage tanks, broken refineries and rerouted shipping could take years to repair.

The world has drawn down more than 500 million barrels of stored oil since the crisis began. U.S. crude inventories, including the Strategic Petroleum Reserve, sit at lows last seen in the mid-1980s (see chart). Those stocks were the cushion that kept oil prices from spiking even further, and they must be refilled. The restocking process means that even after a resolution, rebuilding inventories would create new oil demand.