The oil market has been taking the latest chapter of Middle East tensions relatively calmly. Crude oil prices, despite the initial loss of almost 20 mbpd, only briefly spiked above $100/bbl, a few dollars short of the 2022 peak of $122/bbl and a far cry from the 2008 high of $147/bbl. Products, however, tell an entirely different story. All one needs to do is look at the various CME Group crack spreads. As of July 17, the Heating Oil/WTI differential stood at $88/bbl, just a whisker shy of the record high of $90/bbl reached two days earlier. The RBOB crack settled at exactly $60/bbl, a historic peak. Consequently, the closely followed 3-2-1 crack spread, which in the futures market approximates complex refining margins, flirted with the $70/bbl mark, as illustrated in the accompanying chart.

These are astonishing numbers that lay bare the truly interconnected and global nature of the oil market. The obvious question, therefore, is how long this strength can last and whether a price reversal is imminent. The answer lies in the level of U.S. product inventories, which is profoundly affected by the two pivotal geopolitical events confronting the global economy: the sporadic but unpredictable disruption of traffic through the Strait of Hormuz and the conflict in Eastern Europe, where precise Ukrainian drone strikes continue to inflict significant damage on Russian oil infrastructure, creating an additional shortage of refined products.

These hostilities have elevated the U.S. to the role of the world's swing supplier and exporter of marginal barrels. Strong U.S. product exports are keeping both distillate and gasoline inventories well below their long-term historical norms, which, in turn, keeps days of cover—the number of days stockpiles can satisfy domestic demand—worryingly low.

Although the latest EIA weekly report, covering the period ending July 10, showed an abrupt increase in distillate inventories and, consequently, in days of cover, both metrics remain severely depressed. Their inverse correlation with the CME Group 3-2-1 crack spread is evident in the accompanying chart. Only when days of cover return to their long-term average of around 30 days and remain there for several consecutive weeks would it be reasonable to expect a meaningful retreat in the crack spread. Such a development is likely only if the situation in both the Persian Gulf and Russia normalises in a credible and sustained manner.

While the state of affairs in both regions remains fluid and largely dependent on the actions of the principal parties to the conflicts, it is worth noting that the EIA, in its latest Short-Term Energy Outlook, does not envisage any significant improvement in days of cover for either gasoline or distillate inventories. Both are projected to remain below 30 days throughout 2027, with gasoline averaging around 26 days and distillates around 29 days. This metric is therefore essential to monitor for clues about the outlook for the U.S.—and, by extension, global—refining margins.