Global Energy - August Commentary

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This month we consider two important developments causing higher oil and oil product prices in the middle of 2026: first, an escalation in the Middle East supply shock as Iran-backed Houthi rebels in Yemen have entered the conflict, causing shipping disruption and infrastructure damage around the Red Sea and the Bab al-Mandeb Strait; and secondly, the development of a very significant bottleneck (and hence record margins) in the global refining system which has been caused by Ukrainian attacks on Russian infrastructure, Strait of Hormuz disruptions and Chinese oil product export limits.

The importance of the Bab al-Mandeb Strait to global energy markets

The Bab al-Mandeb Strait connects the Indian Ocean and Gulf of Aden to the Red Sea, thereby providing access for Middle Eastern crude via the Suez Canal and SUMED pipeline to the Mediterranean Sea and to European markets. The strait, which is around 32km wide at its narrowest point, is bounded by Yemen to the north and both Djibouti and Eritrea to the south. According to the U.S. Energy Information Administration (EIA), roughly 12% of global seaborne oil and 8% of global liquified natural gas (LNG) trade typically passes through the combined Bab al-Mandeb, Suez Canal and SUMED route which provides access between the Mediterranean Sea and the Arabian Sea.

The Bab al-Mandeb Strait and the Strait of Hormuz

Source: EIA, June 2026

While not as important as the Strait of Hormuz, the Bab al-Mandeb Strait has long been a very significant chokepoint for world energy markets.

Its significance has grown over the last 10 years as Iranian-backed Houthi rebels in Yemen have carried out attacks on shipping. Since the start of the Israel-Hamas war in 2023 they have expanded their range of targets from just UAE and Saudi shipping to Israeli and then all international shipping. Their threat to shipping was sufficiently high that major shipping companies chose to divert vessels around the Cape of Good Hope, adding roughly 10-15 days to shipping times, rather than risking a passage through the strait. The US military carried out air strikes against the Houthis in early 2024 and their threat receded somewhat with the group not playing much of a role in the early stages of the US/Israel-Iran war.

This changed last month when Iran asked the Houthis to be prepared to close the Bab al-Mandeb Strait if the United States struck Iranian power infrastructure. The Houthis reacted, formally announcing a maritime blockade of Saudi Arabia on 20th July and warning that vessels loading or discharging cargo at Saudi ports could be attacked. The threat was deemed strong enough that several tankers altered course, delayed voyages, or diverted north from the Saudi port of Yanbu on the Red Sea toward the Suez Canal, taking a route to Asian markets around the Cape of Good Hope rather than risk going south through the strait. On 23rd July, two Saudi tankers were attacked and then, on 26th July, Saudi onshore facilities at Yanbu and Jizan were also attacked, with commercial traffic through Bab al-Mandeb falling to its lowest level in months. At the time of writing, tensions are still high and the Houthis were said to be considering charging transit fees on commercial vessels using the strait, similar to Iranian demands over the Strait of Hormuz.

The addition of attacks in the Bab al-Mandeb Strait adds further risks to the current energy supply shock. Vessel disruption causes longer voyage times (Europe-bound cargoes can add roughly 10-15 days of sailing time depending on origin and destination, adding maybe $2/bl to transportation costs) and higher tanker rates (as more ships are required to transport the same volume of oil). The emergence of another shipping hotspot raises the overall risk profile again, adding further to the geopolitical risk premium that has built up over the last five months and is a reminder that energy infrastructure is, by all accounts, possible to target militarily.

A refining bottleneck emerges, causing record refining margins

While Middle East oil and oil product supply disruptions continue, it has become increasingly clear in recent weeks that the tightest part of the energy supply chain is, in fact, the downstream (covering refining operations) and not the upstream (covering oil production activities).

At the end of July, the European generic refining margin was at a record high of around $78/bl (up from $22/bl at the start of the year), while the US generic refining margin was at a record high of around $62/bl (up from $17/bl at the start of the year). The reaction of refining margins, in both regions up 3.6 times, has been much more significant than that of crude oil prices, where Brent and WTI are both up 1.5 times since the start of the year. This indicates clearly that the bottleneck in the global oil system is in refining, most notably in the western hemisphere, rather than in oil production or oil/oil product inventory.

European and US refining margins (US$/bl)

Source: Bloomberg, data to 31.07.2026

The reasons for the bottleneck are global and both long-term and short-term in nature.

First, there is limited global refining capacity as the downstream has typically been a lower-profitability activity and, especially in the west, oil companies have been closing refinery capacity and diverting capital towards higher-return opportunities. In addition to lower western refining capacity, the region also had low diesel, jet fuel and product inventories at the start of 2026 reflecting a weak demand outlook and an oversupplied oil market expected at the start of 2026. This inventory situation has worsened over the year with most recent data showing that OECD commercial diesel stocks are 11% below seasonal norms while refined product stocks are still low across major storage hubs including Amsterdam-Rotterdam-Antwerp (-23% year-on-year) and Singapore (-14% year-on-year).

Secondly, there have been two key sources of refinery capacity reductions so far in 2026.

• Infrastructure damage and shipping disruption from the US/Israel-Iran war has caused refined product exports from west of Hormuz to fall (tracking around 3 mb/d below last year's level in recent weeks). The Persian Gulf usually supplies around 5m b/day of oil products and is one of the world’s largest sources of diesel. Europe has historically been very dependent upon Gulf exports, with roughly a fifth of its diesel and half its jet fuel demand being supplied from the region.
• In addition, in more recent weeks, we have seen an increase in Ukrainian drone and missile attacks that have reduced Russian refining capacity by somewhere between 2.5m and 4m b/day (representing 37-55% of total capacity). Russia – historically the world's second-largest diesel exporter with around 11% share of global seaborne trade – has now banned diesel exports for all of 2026 and has recently had to rely on importing gasoline from countries such as Morocco.
  Russian refinery outages (m b/d)

Source: Morgan Stanley, August 2026

Another factor is that China limited the export of oil products in reaction to the US/Israel-Iran war at the start of March 2026, meaning that Chinese refinery runs have fallen sharply. In June, China was processing around 12.2m b/day of crude oil, down almost 18% year-on-year and close to a four-year low. This has effectively reduced the world's refining capacity even further.

China refinery runs (m b/d)

Source: Morgan Stanley, August 2026

Disruption in the Gulf and Russia together with the export ban in China collectively appear to be reducing global refinery runs by around 7m b/day versus the same period in 2025. This sharply lower production of oil product, when combined with the already low inventory position at the start of 2026, has caused oil product prices to rise sharply and refining margins to expand to the record levels witnessed at the end of 2Q 2026. Higher margins are incentivising refiners (that are able) to maximise refining volumes and adjust product slates to maximise the production of diesel and jet fuel. For example, US refinery utilisation reached at 97.2% at the end of July, the highest seasonally adjusted level for nearly 30 years and substantially higher than the 10-year average of 91.7%. Nonetheless, the additional volumes have not been sufficient on a global basis, and they are unlikely to be sufficient to dampen prices much in the remainder of 2026.

The bottleneck in the global refining system is a reminder that the world consumes oil products rather than oil per se and that the downstream business, having been oversupplied for many years, can be a profitable activity. We estimate it takes between five and 10 years to build a new refinery and, with little new refining capacity currently under construction (with only 0.5-1.0m b/day of new capacity being completed in the next couple of years) it appears that refining operations will remain exceptionally profitable until Gulf and Russian refining capacity comes back online. In the words of Saudi Aramco CEO Amin Nasser on August 4, 2026 "the refining system today, excluding stranded Arabian Gulf and Russian refineries that have been under attack, is stretched and is operating at near maximum utilisation rates". We expect refining margins to remain elevated for some time.

The value of this investment can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you invested.