Diesel crunch deepens as shipping costs squeeze global oil trade

Crude flows from the Persian Gulf are recovering toward pre-disruption levels before the US-Iran war, but diesel and shipping markets remain under severe strain, prompting Asian and European buyers to seek more US oil and refined products, executives from Phillips 66 and Occidental Petroleum said Oct. 7.

Diesel remains acutely tight as the Middle East disruption coincides with reduced Russian refinery output and lower Chinese product exports, Mark Senn, Phillips 66 senior vice president of global trading and commercial, said at the Baker Institute's annual energy summit in Houston.

Ukrainian attacks have systematically targeted Russian refineries, curbing a major source of fuel exports, while China has reduced or at times halted product shipments, leaving US and European plants to cover more of the shortfall.

Phillips 66 has responded by running all its refineries in "max diesel mode," seeking to extract every additional barrel while operating safely, Senn said, as Gulf crude loadings were moving closer to pre-disruption levels, but lost refining capacity and export supply made diesel substantially harder to replace.

Tracking the crude recovery remained difficult because some tankers switched off transponders while transiting the Strait of Hormuz. Even so, crude availability was improving, whereas diesel balances remained the tightest part of the barrel, Senn said.

Oxy Senior Vice President of Energy Services Geoff Houlton cautioned that crude markets had not yet reached a comfortable position. Inventories had continued to decline in recent weeks, leaving the market exposed to further disruption even as Gulf loadings improved, he said.

OPEC remains a useful buffer, although it cannot impose its will on its largest members, former US Ambassador David Satterfield said during a separate panel at the summit. "Without OPEC, the degree of uncertainty, even in an admittedly uncertain market, would be much greater," he said.

Shipping has become another critical constraint. Houlton cited a Gulf Coast-to-Asia very large crude carrier fixture at about $80 million, equivalent to roughly $40/b. That would lift the delivered cost of crude priced near $90/b to about $130-$140/b for an Asian buyer, illustrating how freight can erode the advantage of replacement supplies even when the oil itself is available.

Higher insurance costs, longer voyages and the use of tankers for short shuttle runs around the Gulf have reduced the vessels available for long-haul trade, the panelists said.

Satterfield said Iran had demonstrated that it could close the Strait of Hormuz, giving Tehran a significant form of power projection over global oil markets. He expected abnormal market and production conditions to remain the norm for about two years as Iran seeks to outlast US-led sanctions and the naval blockade while avoiding actions that would trigger a major military response.

Middle East barrels rerouted through the Red Sea can add about 20 days to voyages to Asia, Houlton said. Tonnage has also tightened sharply in the Aframax and Suezmax segments, making it increasingly difficult to split very large crude carrier cargoes, according to shipping market sources.

Charterers avoiding high VLCC rates would typically book multiple Suezmaxes or Aframaxes instead, but the shortage of those smaller vessels is limiting that alternative. Asian refiners still need the crude and strong refining margins are supporting their willingness to secure replacement barrels despite elevated freight costs.

The disruption is also redirecting trade toward the US. Senn said Asian buyers were showing greater interest in LPG from Phillips 66's Gulf Coast system, while Asian and European refiners were approaching the company's Beaumont terminal for crude.

Houlton said Japan, which had sourced nearly all its crude from the Middle East before the shock, moved from taking almost no US crude to obtaining about one-third of its imports from the US over the summer—a rapid diversification by one of the world's most import-dependent markets.

Import-dependent governments are considering larger strategic stocks and a broader supplier base to reduce exposure to a single route or region, while Middle East producers may position inventories closer to consuming markets so that barrels remain accessible if another chokepoint closes. Rebuilding those stocks after the disruption could provide a tailwind for oil demand, Houlton said.