A relatively obscure crude oil price differential is gaining traction as a key inflation barometer, and it is now widening at an alarming pace. Bank of England Governor Andrew Bailey stated on Tuesday that he is placing more emphasis on the expanding "crack spread" 鈥?the margin between refined product prices and unprocessed crude oil 鈥?rather than headline oil prices alone. His remarks align with a growing consensus among economists, including those at the European Central Bank, who are monitoring fuel prices more intently than crude benchmarks.
The reason is stark: two major conflicts 鈥?the US-Iran war and the Russia-Ukraine war 鈥?have eliminated millions of barrels of daily refining capacity. With insufficient output of refined products, fuel prices are surging dramatically. In Europe, motorists are now paying the equivalent of over $370 per barrel for gasoline and diesel at the pump. Bailey noted that "we don't actually consume barrels of crude oil" but rather the finished products derived from it, explaining that "the crack spread is evidently the wedge between crude prices and product prices, and that wedge has expanded. It is currently at elevated levels."
Why the crack spread keeps widening
Bailey is not alone in focusing on fuel premiums. In late July, the European Central Bank highlighted the crack spread and the inflation risks posed by refining capacity constraints driving up gasoline and diesel prices. These factors are reinforcing interest rate expectations in ways that benchmark oil price movements alone cannot fully capture. Earlier that same month, asset management giant Vanguard disclosed it had purchased hedges against "US inflation being more stubborn than expected" due to the widening crack spread. Meanwhile, US President Donald Trump has urged American refiners to boost domestic gasoline and diesel output, as higher transport costs could fuel inflation and pressure Republicans ahead of the crucial November midterm elections.
Industry analyst Brett Gibbs noted that, in recent memory, economists have typically tracked headline crude prices to gauge the broader oil market, while governments focused on securing access to unprocessed crude to manage prices overall. However, since the Iran war effectively closed the vital Strait of Hormuz earlier this year, crude prices have not reached the feared $200-per-barrel level. Pre-war supply gluts, record US exports, unexpectedly weak Chinese demand, and a trickle of crude still transiting the waterway have all helped cushion the shock. But the refined products market has proven far harder to tame.
Refineries have become direct targets in both the Middle East conflict and the escalating Russia-Ukraine war. The Russian government imposed a diesel export ban after attacks on its refineries 鈥?diesel being a critical supply source. Additionally, shipments of petroleum products through the Strait of Hormuz have been more severely disrupted than crude flows. This is because refined fuels require more individual vessels for transport, and unlike the crude market, there is no dominant carrier to coordinate passage across the strait. Gibbs remarked that "the lesson for broader economists this cycle is that you can't always treat crude, gasoline, and diesel as perfectly correlated. We are severely short of refined product output."
On Wednesday, compiled fair value data showed European benchmark diesel futures trading at a premium of roughly $75 per barrel over Brent crude. On January 2, that same premium stood at about $21 per barrel. This translates to a wholesale diesel price of around $175 per barrel. After accounting for taxes and retail margins, pump prices are substantially higher still. Russell Hardy, chief executive of the world's largest independent oil trader Vitol, issued a stark warning about escalating fuel market pressures. Speaking at a conference in Singapore on Tuesday, he estimated that drone attacks have cut Middle East refined product exports by approximately 2 million barrels per day, with Russia contributing a further reduction of around 2 million barrels per day.
The Bank of England's latest Monetary Policy Report from July estimates that higher energy prices will contribute approximately 0.4 percentage points to CPI inflation in the second half of this year. Gasoline and diesel retail prices alone are projected to average around 0.3 percentage points of that contribution. Rachel Ziemba, an adjunct senior fellow at the Center for a New American Security in Washington, observed that "central bankers are always looking for new leading indicators of inflation. Refined product prices measure pain more accurately than crude oil alone because they are in tighter supply and because these are the products that individuals and businesses actually use."