Low-Energy Fridays: Will Ukrainian Strikes Against Russian Oil Refineries Impact U.S. Fuel Prices?

Ukraine has significantly ramped up a relatively new tactic in its war with Russia: repeated drone strikes against Russian oil refineries. The reason I say “relatively” is because then-President Joe Biden asked Ukraine to refrain from such attacks last year based on the fear that it would raise U.S. energy prices. Because peace negotiations brokered by President Donald J. Trump have been unsuccessful thus far, it appears as though the White House is no longer inclined to restrain Ukraine. But the question remains whether the Biden administration’s concerns about gasoline prices are justified.

Basic economics tells us that yes, reduced gasoline supply—even elsewhere in the world—will impact fuel prices. However, it may not be to the degree feared, as the nature of that impact depends on global market conditions as well as policy reactions to Russia’s fuel shortages.

While the Russian government’s tight control over their domestic media makes the accuracy of economic impact reports hard to gauge, it is estimated that up to a fifth of Russia’s refining capacity has been put out of operation. What we can confirm is that the attacks thus far have largely focused on refineries rather than oil production. This means that although Russia is still producing and exporting lots of oil, they’re having a hard time turning it into enough usable fuel to support their economy. And while there are confirmed reports of fuel scarcity in more rural eastern areas of Russia, its denser western regions seem to be less affected—potentially reflecting the country’s choice to direct its limited fuel supply to the areas viewed as most important.

So, Russia has two options: Use less fuel or import more of it. Gasoline prices in other parts of the world may not be affected too adversely by the first option due to the reduction in demand matching the reduction in global refining capacity; however, the second option carries more implications for the global economy.

Russia is ramping up its fuel imports, which will affect fuel prices elsewhere by raising demand relative to increasingly scarce refining capacity. This can have an indirect effect on U.S. fuel demand because even if Russia isn’t importing fuel from the United States, it may import fuel from other countries that shore up their resulting shortfalls with U.S. imports. But what would the degree of this effect be?

It’s impossible to know at this juncture how much fuel prices could increase, but past events offer some insight. In 2022, shortages of refinery capacity in the United States caused the price of finished petroleum products to increase relative to the cost of oil. At that time, the “crack spread” (don’t laugh— it’s a real term) increased from about $16 per barrel of oil to $60 per barrel. With 42 gallons per barrel, that meant the profit margin of refining increased from $0.38 per gallon of gasoline to $1.43 per gallon.

For what it’s worth, there isn’t much evidence at this time to say the current situation could get that bad. For one thing, we have more refining capacity now than in 2022. For another, because the refinery capacity shortage is in Russia this time, the impact on prices would disperse across global refiners seeking to trade to more profitable markets.

There is another (often forgotten) issue at play: currency appreciation, or the change in value of U.S. dollars relative to other currencies to support trade. If Russia seeks to import more fuel, it will have to pay for it in foreign currencies (not rubles). To the extent that U.S. refiners may export more gasoline, they would seek compensation in the form of U.S. dollars, which would increase the demand for dollars and cause its value to rise relative to foreign currencies. A higher dollar value can partially insulate Americans from the rise in prices, as the increased purchasing power of the dollar counteracts inflation.

The inverse of this phenomenon also explains why Russia has been able to sustain its war effort for so long. Even though the ruble’s value collapsed, domestic budgets became easier to support with exports paid for in higher value foreign currencies.

All that is to say that because oil and gasoline operate in global markets, events in one country can impact others—although it’s hard to know to what degree.

As a matter of policy, it is essential to note that the United States’ support for Ukraine is a signal to other potential belligerents that we will support its friends and uphold international sovereignty. The message from the Biden administration was that the United States will do all that, so long as pump prices don’t increase. That is the opposite of a successful foreign policy strategy, as it clearly communicates to adversaries the conditions under which the United States can be browbeaten into withdrawing support (something I wrote about at the onset of the Ukraine-Russia war).

So in short, yes, Ukraine’s attacks on Russian refineries will have at least some impact on prices as a matter of basic economics. But those impacts will be dispersed globally and are hard to predict. And even though some impact to fuel prices is likely, in the grand scheme of foreign policy, it may be worth demonstrating that the United States is not so easily cowed.