Oil, Gas and Diesel Prices Surge as Middle East Conflict Deepens

Russell Hardy, chief executive of Vitol, addressed an oil conference in Singapore last week, and his perspective differs meaningfully from that of the financial markets, where paper oil changes hands in vast volumes without a single barrel moving. Vitol, by contrast, deals primarily in physical trading, moving approximately eight million barrels of crude oil and petroleum products daily.

When Hardy discusses fuel shortages, he is not extrapolating from a price chart. Vitol has to source those barrels somewhere in the physical world and then deliver them to customers, which gives his warnings a different weight than market commentary alone.

This week, Hardy pointed to a problem that may prove more consequential than oil prices exceeding $100 a barrel. The market, he said, is short approximately two million barrels of petroleum products a day from Russia and nearly another two million from the Middle East, a deficit that global reserves are only partially absorbing.

Hardy's own framing is straightforward: the world is still drawing down reserves accumulated in earlier years and is now nearing the bottom of them. His assessment of the Strait of Hormuz reinforces the point. Approximately nine million barrels of crude oil and one million barrels of refined products still flow through it daily, roughly half the normal volume.

Why Diesel and Gas Are the Real Story

However, two commodities capture the severity of the situation most clearly: diesel and the natural gas traded in Europe. Prices for petroleum products traded on the ICE Futures Europe exchange under the London Gas Oil contract have climbed back to levels last seen at the peak of the crisis in early April, having fallen back in the interim. Since July, that decline has reversed, and diesel is now approaching $200 a barrel.

A Brent price of around $100 may already look expensive, but the more significant pressure builds further down the supply chain, at the refineries, where refined diesel now costs nearly twice as much. That gap matters because transport costs feed directly into the price of almost everything that moves, from freight to public transport, which is why energy shocks tend to spread into broader inflation faster than headline crude prices suggest.

Natural gas tells a similar story. Prices have reached €81 ($94) per MWh, the highest level since the end of 2022, a rise of more than 38% over the past month. The underlying cause is structural rather than cyclical: storage facilities are only about 67% full, well below the five-year average of around 84% for this time of year.

The shortfall is most acute in Germany, where companies are expected to raise rates significantly ahead of the heating season. The mechanism echoes the Ukraine energy crisis, since gas prices feed directly into electricity prices across Europe through gas-fired power plants, meaning a second energy shock is already working its way through the system.

Central Banks Move Before Inflation Does

Central bankers, unlike politicians, appear to have absorbed at least part of the lesson from the previous inflation cycle: high oil, gas and transportation costs tend to feed into consumer prices with a lag.

South Korea moved first, raising rates twice in a row over the summer. The Reserve Bank of New Zealand followed the same logic, raising rates ahead of the Federal Reserve's September meeting rather than waiting for Washington to set the pace. On Thursday, the European Central Bank (ECB) joined them, moving despite rising government bond yields across Europe.

The ECB raised the deposit rate by 25 basis points, from 2.25% to 2.50%, with the main refinancing rate rising to 2.65% and the overnight rate to 2.90%. This marks the second increase this year, following June's hike, itself a direct response to the inflationary effects of the war in the Middle East.

The logic is straightforward. Eurozone inflation accelerated to 3.3% in August, reversing what had looked, only months earlier, like a credible path back to the ECB's 2% target. Energy prices are driving that reversal, with the energy component rising 14.3% year-on-year in August, even as core inflation remains comparatively contained at 2.4%.

The Limits of Monetary Policy

However, this does not amount to victory for the ECB. If anything, the bank finds itself in an increasingly uncomfortable position. Raising interest rates will not reopen the Strait of Hormuz, nor will it refill gas storage facilities faster. The ECB's move functions less as a solution than as a signal, intended to discourage companies from passing rising energy costs on to consumers too readily. Markets understand this distinction, which is precisely why they also understand how limited the ECB's room for maneuver actually is.

European bond markets already make aggressive rate increases difficult to sustain, and recent state election results in Germany suggest that further hikes would carry a political cost, gradually eroding support for one government after another.

The United Kingdom, France, Germany and Italy all face a version of the same underlying vulnerability. Whenever yields on 10-year bonds exceed nominal economic growth, that divergence functions as an early warning sign of fiscal strain.

The deeper risk emerges once these higher rates work their way into the refinancing of national debt, at which point the ECB will effectively be presiding over a genuine bond-market crisis across Europe. Raising rates, then, is less a solution than a symbolic gesture, one that signals concern without addressing the scale of the problem it responds to.