Record Profits of Oil Giants: Refining Bottlenecks Replace Oil Prices as the New Engine of Inflation, U.S. Inflation Faces a Second Surge

The average price of unleaded gasoline in the United States has quietly risen to over $4 per gallon. Exxon Mobil Corporation (XOM.US) and Chevron Corporation (CVX.US) warned this week that global supplies of diesel and other refined products may remain tight, pushing prices higher in the coming months. Both companies reported significant increases in refining profits for the second quarter on Friday. Currently, due to the war in the Middle East and Russia disrupting supplies, combined with depleting fuel inventories, global refining capacity is in extreme shortage. According to data from Melius Research, nearly 10% of global crude refining capacity is effectively paralyzed due to the closure of much of the Strait of Hormuz, ongoing attacks by Ukraine on Russian refineries, and export bans from China. As a result, major refineries are operating at full capacity to meet demand, which means that even if crude oil is available for processing, they are unable to produce more fuel. This situation has led to record-high refining profits, benefiting refinery owners while increasing costs for consumers. Exxon Mobil's refineries along the U.S. Gulf Coast achieved a capacity utilization rate of 95% in the second quarter, while Chevron's U.S. refineries reached a utilization rate of 97% during the same period. Exxon Mobil Corporation CEO Darren W. Woods stated during the company's earnings call, I have never seen available capacity so low relative to demand, adding, The entire industry will take quite some time to work its way out of this predicament. Exxon Mobil's Chief Financial Officer Neil Hansen remarked that the biggest bottleneck for the oil market is not necessarily the disruptions in oil transport through the Strait of Hormuz, but rather the scarcity of global refining capacity. Hansen noted, The available refining capacity is at the lowest level we have seen, mainly driven by market dynamics outside the Strait of Hormuz. This has indeed resulted in record refining margins. Exxon Mobil reported that its diesel production in the second quarter hit the highest level for any single quarter since 2014, with its refining segment generating $5.5 billion in profit, significantly higher than the $1.4 billion profit during the same period last year. Chevron CEO Mike Wirth pointed out during the company's earnings call that as countries in the Northern Hemisphere stock up on heating oil ahead of winter, the intermediate refined oil market, which includes diesel, jet fuel, and heating oil, may tighten further. Wirth stated, I believe that into the third quarter and even beyond, we will see some upward pressure on refined product prices. Rob Thummel, a senior portfolio manager at Tortoise Capital Advisors, mentioned in his report that gasoline prices are starting to decouple from crude oil prices, trading more in line with inventory levels. The refined oil inventory is nearing historical lows, Thummel said, adding, Gasoline prices are becoming less influenced by crude oil price fluctuations and more reflective of changes in inventory levels. Concerns of a secondary rebound in U.S. inflation In recent months of macroeconomic discussions, the market has grown accustomed to viewing international crude oil prices as a barometer for judging U.S. inflation trends. However, as global refining capacity experiences structural tightness, a more insidious and destructive mechanism is forming behind the record profits earned by refining giants like Exxon Mobil and Chevronhigh refining margins are replacing crude oil prices themselves as the dominant force pushing U.S. terminal inflation higher. Traditionally, it has been believed that as long as crude oil supplies remain stable, prices at the pump would subsequently drop. However, the current market fractures lie in the refining bottleneck. Due to conflicts involving GEO Group Inc causing shipping route disruptions, Ukrainian attacks on refineries, and export bans from some countries, nearly 10% of global refining capacity is rendered inactive. Even if crude oil prices remain stable or decline slightly, extremely high crack spreads still push gasoline and diesel retail prices to elevated levels. This means that even if the government injects crude oil into the market through the release of the Strategic Petroleum Reserve (SPR), it cannot solve the physical bottleneck of insufficient refiners to process it into fuel. The decoupling of crude oil supply from refined product supply results in terminal fuel prices exhibiting strong downward stickiness. For U.S. inflation, gasoline prices directly influence consumer perception, but the high profits from diesel and intermediate refined oils, paired with extremely low inventories, pose a more severe threat to the overall economy's secondary transmission. Diesel is the lifeblood of heavy-duty trucks, rail transport, and agricultural machinery. When refineries push diesel profits to historic highs, the execution costs for transportation companies soar, quickly transferring these costs to retailers and suppliers like Shenzhen Agricultural Power Group in the form of fuel surcharges, thereby cascading into terminal food and consumer prices. The scarcity of jet fuel is driving up ticket prices, while heating oil continues to rise during the fall and winter stocking season. These factors are directly contributing to inflation in the service sector. Even as prices for some core goods decline due to supply chain recoveries, high energy and logistics costs are continually squeezing the margin for price reductions. The Federal Reserve's decision-making dilemma The fuel premium resulting from high refining margins greatly complicates the Federal Reserve's goal of returning inflation to the 2% target. High gasoline prices are the most readily perceived economic indicator by the public. Persistently high oil prices easily raise long-term inflation expectations among households, posing risks of a wage-price spiral. In the fight against inflation's last mile, the ongoing positive pull from the energy sector on the CPI will force the Federal Reserve to maintain a more hawkish stance, delaying interest rate cuts or slowing the pace of easing, thereby exacerbating the Fed's policy dilemma between anti-inflation and stabilizing growth. The current high profits in the refining industry are not merely a short-term phenomenon; they reveal deeper contradictions stemming from a lack of investment in refining infrastructure in the context of global energy transition intertwining with the impacts of GEO Group Inc. As long as refined capacity supply cannot be released rapidly, high refining margins will persist as a form of invisible tax, permeating various levels of the U.S. economy. This dictates that managing inflation in the U.S. will not only depend on observing crude oil supplies but also must contend with the long-term stickiness presented by the refining sector.