Energy & Precious Metals: Weekly Review and Outlook

By Barani Krishnan

The Federal Reserve is resolutely focused on preventing a recession in the U.S. as it strives to manage inflation driven by energy costs through the most aggressive rate hikes seen in a generation. However, many analysts believe that the central bank may struggle to achieve this goal. The pressure on the economy is not solely a result of external factors like high oil prices from OPEC, but rather a significant number of U.S. fuel refiners who are prioritizing substantial profits at the expense of broader economic stability.

Refiners like Marathon Petroleum and Valero Energy are operating within legal boundaries while maximizing returns for their shareholders. The real issue lies in a critical shortage of gasoline and diesel, exacerbated by the closure and downsizing of several refineries during the pandemic. Those remaining in the refining business are capitalizing on the situation by limiting production, rather than reinvesting profits in expanding operations or reopening idle facilities.

Recent estimates indicate that over 1 million barrels per day of U.S. refining capacity—about 5%—has been lost since the onset of the COVID-19 pandemic, with additional reductions globally. Without plans for expansion, the supply crunch is expected to worsen.

Bloomberg’s energy analyst Javier Blas highlighted that fuel prices are rising more rapidly than crude prices, presenting a hidden economic crisis. He noted that while crude prices are stabilizing at around $110 per barrel, prices for refined products like jet fuel and diesel are surging, impacting consumers deeply.

Historically, the profit margins in refining, known as the crack spread, hovered around $10.50 per barrel. However, during the “golden age” of refining from 2004 to 2008, this spread exceeded $30, and recently, it has skyrocketed to nearly $55 due to supply shortages amidst recovering demand that’s nearing pre-pandemic levels.

The ongoing crisis is compounded by geopolitical factors, such as sanctions on Russian energy products, which have further strained global fuel supplies. The Saudi Energy Minister acknowledged the closures of many refineries worldwide and warned that the energy capacity crisis is prevalent beyond the U.S.

The situation could worsen, particularly on the East Coast, as the owner of a major refinery and fuel station chain suggested that diesel rationing may soon be a reality. However, while gasoline prices are soaring, a scarcity of gasoline is not expected; rather, consumers will face historically high prices.

Truckers are rushing to stock up on diesel in anticipation of continued high demand, with executives noting that despite soaring prices, demand isn’t easily suppressed. Some analysts are concerned that if fuel prices remain high, a significant reduction in demand could follow, negatively impacting the broader economy.

The International Energy Agency has cautioned that rising gasoline prices, combined with a slowdown in economic growth, will likely limit demand recovery through the rest of the year. Observers are also closely monitoring the Federal Reserve’s approach to interest rate increases, which are critical in shaping economic conditions.

The Fed has initiated a series of rate hikes and projections suggest the central bank may continue this trend, despite potential risks to the economy. Increased rates may compound the challenges that businesses face from soaring fuel prices, possibly leading to broader economic repercussions.

Market analysts warn that excessive rate hikes might destabilize the economy further, especially as inflation continues to outpace economic growth. A prominent concern is achieving a "soft landing" for the economy as the Fed navigates the intricate balance between curbing inflation and avoiding a recession.

As energy refiners enjoy sizeable profits, the ramifications for the economy might deepen, forcing a reduction in demand and potentially leading to an economic downturn.

Disclaimer: The author does not hold positions in the commodities and securities discussed in this article.