An Urban's Rural View

The Iran war, now in its sixth month, has not hit crude oil prices as hard as many had feared. That's not much comfort to American farmers using diesel fuel.

The price relationship between diesel and crude -- the crack spread -- has been out of whack for years, owing first to refinery closures in the U.S. and later to the Russia-Ukraine war. The Iran war has widened the spread still further.

Some U.S. farmers have seen diesel prices 50% higher. (https://www.dtnpf.com/…) They're undoubtedly wondering where the price of diesel is headed now.

To answer that question, let's start by reviewing what's happened thus far. When the war began, crude was selling for around $70 a barrel. Its price peaked around $115 in April, far below the $200 some analysts had predicted. Lately it's been selling in the eighties, 10% or so higher than before the war. (https://fred.stlouisfed.org/…)

Fortunately, the world's crude inventories were high going into the war. The International Energy Agency was able to coordinate Western allies' withdrawals from emergency reserves. China was able to cut its imports a few million barrels a day, partly by drawing down inventories and partly by cutting off exports of refined products to Southeast Asia. (https://www.foreignaffairs.com/…)

Now, though, reserves have been drawn down, limiting their ability to mitigate price pressure. If traffic through the Strait of Hormuz continues to be restricted, crude's price will rise again.

If the pre-Iran war crack spread had remained unchanged, this year's increase in diesel prices would have tracked crude. Instead, the Iran war damaged refineries in Saudi Arabia and Kuwait. It also severely limited shipments of refined products through the Strait of Hormuz. The crack spread widened further.

The national average retail price of diesel is $5.50 a gallon, up more than 40% from when the war began Feb. 28. (https://gasprices.aaa.com/…) Contrast that with the 10% or so increase in crude.

Farmers pay less because their diesel isn't taxed and their price differs from state to state. But the farm diesel crack spread has also widened in a big way.

What happens to diesel prices now depends, first, on what happens in the war. An end to hostilities with a reopening of the strait would lower crude prices and, to some extent, narrow the crack spread.

Don't count on a return to pre-2022 spreads, though. Diesel inventories in many parts of the world are low; they'll need to be rebuilt. Repairing damaged Middle Eastern refineries will take months. Though Vice President JD Vance has been pushing Ukraine to halt drone attacks on Russia's oil infrastructure, a freer flow of Russian diesel exports isn't guaranteed.

A return to normal traffic through the Strait of Hormuz may not happen soon, however. Hostilities are far from ending.

The Iranians are insisting they won't agree to a peace deal that doesn't give them control of the strait. (Even if they relent on that, they've shown they can disrupt shipping through the strait any time they want to.)

President Donald J. Trump appears to have given up on bombing the Iranians back to the stone age. He's once again applying economic pressure, blocking the Strait of Hormuz. Treasury Secretary Scott Bessent is talking about new, tougher sanctions on Iran.

Will the Iranians cave?

Though the war has devastated their economy, they think they have the upper hand. The hardliners running the show in Tehran believe Trump needs to get the strait opened and the price of oil down before the midterm elections in November. They're preparing to endure severe economic privation, convinced that Trump will blink first. (https://www.wsj.com/…)

Could they be right? Trump clearly wants to end the war. Vance says opening the Strait of Hormuz is the administration's top priority, higher even than ending the possibility of Iran acquiring a nuclear weapon.

If, to get the Strait of Hormuz open, Trump accepts what the Iranians are demanding -- recognition that they control it -- the war will end with Iran in a stronger position than before the war. Trump might try to paint that deal as a victory, but he would fool no one.

To get a deal for which he can credibly claim victory, Trump might have to outwait the Iranians. Maintain the blockade indefinitely. Accept higher crude, diesel and gasoline prices indefinitely. Count on economic hardship to force Iran to yield even if it takes months. And months.

Iran's rulers have a history of not backing down, of accepting hardship, of letting their people suffer. In their war with Iraq in the 1980, they could have had a peace deal after two years. They fought for another six years before accepting a draw.

The longer they hang tough this time, the longer diesel prices will remain elevated.

Urban Lehner can be reached at urbanize@gmail.com

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