The biggest oil risk is at the bottom of the barrel

By Javier Blas

In the oil industry, fuel oil is known as the bottom of the barrel. It’s typically cheap, unloved, and, crucially, comes from the bottom of a petroleum-distillation tower — the tall piece of refining kit where crude gets heated and cracked into multiple petroleum products.�� But the Iran war has turned the industry upside down. Fuel oil is now an ultra-expensive commodity — and that’s bad news for the global economy.

Until now, the energy market has weathered the war shock reasonably well, with oil hovering at around $100 a barrel. But the situation with fuel oil is concerning — and it’s not receiving enough attention. Overshadowed by the other stuff coming higher up from the distillation process — diesel, jet fuel, and, above all, gasoline — fuel oil plays a huge role in the modern world, powering the workhorses of globalization: container ships.

The problem isn’t just that it’s getting crazy expensive; the real worry is that some key ports may run dry, forcing all kinds of ships, from container vessels to bulk carriers, to halt. The shipping industry, which is typically conservative in its public pronouncements, is sounding the alarm. Vincent Clerc, the chief executive officer of shipping giant AP Moller — Maersk A/S, told French newspaper Le Monde this week: “If we do nothing, we risk ending with dry supply points in Asia.”

Based on my industry soundings, fuel-oil supply is very low in two of the top-three bunkering locations: Singapore, and Fujairah in the United Arab Emirates. Problems are starting to emerge in several other places within the top 10, although supply is good in Europe and American ports. The issue is exacerbated because the world has already used its main lines of defense against an oil shock: bypassing refineries, and tapping strategic petroleum reserves. Going forward, only demand destruction via higher prices, can keep consumption in line with available supply.

Wall Street closely monitors the price of crude, particularly a grade called West Texas Intermediate (WTI) that trades in New York and a second called Brent traded in London. It’s a benchmark followed by everyone, from bond investors to central bankers. But only oil refiners buy crude — and are therefore exposed to its price. The real world purchases refined petroleum products such as gasoline, diesel, and fuel oil, so it’s those post-refinery prices that matter to us.

Typically, the price of crude and the price of refined products move in tandem, with the latter a bit higher to take into account refining costs. But times aren’t normal. Right now, the traditional relationship between crude and fuel oil is broken. Brent is hovering at $100 a barrel, suggesting that fuel oil prices shouldn’t be much higher, even once you add the average refining margin.* In reality, they are a lot more expensive.

In Singapore, fuel oil is trading at $140 a barrel. In Fujairah, a key refueling port just outside the Strait of Hormuz, it’s changing hands at nearly $160; and some flavors that meet stricter environmental standards fetch as much as $175. Those are unheard of prices, well above the peaks seen in 2022 and 2008. And good luck getting your hands on a barrel: Traders are quoting prices over the phone valid for just a few minutes: on a take-it-now-or-miss-out basis.

The closure of the Strait of Hormuz is to blame. The waterway isn’t just a chokepoint for millions of barrels of crude; it’s also the conduit for lots of fuel oil that’s refined in Saudi, Kuwaiti, and Emirati plants. Together, those refineries produce 20% of the world’s fuel oil that’s traded internationally, according to the International Energy Agency; the Persian Gulf is far less important for other products like gasoline.��

Moreover, Persian Gulf crude yields, on average, more fuel oil than crude from other regions, compounding the problem. Take Arab Light, the flagship Saudi barrel. Put it into a distillation column, and about 50% of what comes out is so-called “residue,” the stuff used to make fuel oil, compared with the 33% from a barrel of WTI. Even when refiners in Asia find alternative crude from, say, the US, or even Russia, the result is less fuel oil output than before.

The shipping and oil industries are rushing to alleviate the problem, shuttling fuel oil from ports in Europe (Rotterdam and Gibraltar, for example) and America (Long Beach and Panama) into Asia. But the longer the Strait of Hormuz remains closed, the higher the risk that ships won’t have sufficient fuel to keep traveling. It may come from the bottom of the barrel, but fuel oil can still become the world’s top problem.

BLOOMBERG OPINION

*Very often, fuel oil cost less than a barrel of oil, with refiners selling it at a loss just because it’s a byproduct of the refining process needed to make what refiners want to sell: high value products like gasoline and diesel.