Our latest insight examines the outlook for the heating oil/WTI spread from CME Group. The chart speaks for itself: the astronomical rise in heating oil prices, both outright and relative to WTI, is the result of several factors.

The most obvious one is the ongoing Iranian conflict. Around 20 mbpd of oil travels through the Strait of Hormuz in peacetime - 15 mbpd of crude oil and 5 mbpd of products, and of the 5 mbpd, two to three are distillates. With global distillate demand at around 28 mbpd, a significant volume has become stranded following the closure of this pivotal artery.

Secondly, the European distillate market, particularly diesel, is tight due to refinery constraints and the gradual phase-out of Russian refined product imports.

These two factors, together with the frequent mismatch in crude oil quality, make U.S. distillates, especially diesel, the marginal barrel for the global market. The growing importance of the U.S. as the leading exporter of this product is illustrated by the relentless rise in the heating oil/WTI crack spread. Before Russia invaded Ukraine in 2022, the average crack spread value rarely exceeded $20/bbl. Over the past four years, it has seldom fallen below $30/bbl.

There is no doubt that the seemingly perennial tension in the Middle East, along with the closure of the Strait of Hormuz, has added further fuel to the fire of the heating oil crack spread. The crack peaked close to $90/bbl at the end of last month, driven by two factors: the Far East, the global manufacturing hub and a key consumer of diesel, and Europe, with its structural distillate shortfall, both turned to the U.S. for supply.

The result has been a steady decline in U.S. distillate inventories, which are now more than 10 million barrels below January levels, according to the latest EIA data. This comes at a time when domestic retail diesel prices are flirting with, or have even exceeded, the $5/gallon mark. U.S. distillate exports are above 1.4 mbpd - more than 10% higher than the 2024 to 2025 average and nearly 30% over the 2021 mean.

The market remains nervous, as the reopening of the Strait is far from certain. Consequently, it continues to react to headlines. When oil begins to flow again through this waterway, both outright prices and crack spreads are likely to weaken considerably.

However, given the structural tightness in Europe’s distillate market and the time (measured in months, not weeks) required for damaged Middle Eastern energy infrastructure to return to full capacity, reliance on U.S. distillates will remain strong. This dynamic is likely to make any dip in the crack spread an attractive buying opportunity.

It is impossible to predict how sharp or prolonged any correction might be. Therefore, those who do not want to miss the opportunity may find it an appealing strategy to scale into positions, buying the differential in the $60 to $40/bbl range.