The Resilience and Upside Potential in U.S. Refining Margins Amid Diesel Shortages and Structural Tightness

The U.S. refining sector is navigating a pivotal inflection point in 2025, driven by a confluence of diesel shortages, structural supply constraints, and divergent regional performance. For investors, this environment presents both risks and opportunities. While near-term volatility persists, the long-term fundamentals of refining margins remain robust, offering a compelling case for strategic positioning in energy equities.

The Structural Tightness Driving Margin Resilience

Diesel refining margins in the U.S. have defied expectations in 2025. After hitting a two-year low of $22.22 per barrel in June, global diesel cracks rebounded sharply, averaging $17 per barrel in Q2 2025 and surging to $21 per barrel by July. This rebound is underpinned by a perfect storm of factors:

1. Global Supply Constraints: Refinery outages in Europe, coupled with a lack of crude suitable for distillate production from Venezuela, Canada, and OPEC+, have tightened global diesel supply. Meanwhile, Middle Eastern and Chinese exports, once a source of oversupply, have failed to offset these gaps.
2. Low Inventories and Export Demand: U.S. distillate inventories reached five-year lows in early May 2025, driven by strong exports to markets in Asia and Europe. This depletion has amplified the sensitivity of prices to incremental supply shocks.
3. Refinery Utilization Dynamics: Gulf Coast refineries continue to operate at 93.5% utilization, a testament to their efficiency and strategic positioning. In contrast, East Coast facilities like Phillips 66's Bayway refinery hover near 59% utilization, reflecting regional bifurcation.

Goldman Sachs analysts project that U.S. diesel margins will remain $10 per barrel above pre-pandemic averages through 2026, with heating oil cracks hitting $28 per barrel—a $5 premium to historical norms. These elevated margins are not a temporary spike but a reflection of a global refining capacity crunch.

Strategic Positioning: Who's Winning and Why

The response from major U.S. refiners highlights divergent strategies to capitalize on—or mitigate—these margin dynamics:

• Valero Energy (VLO): Closed its high-cost Benicia refinery in California, a move to reduce exposure to costly regulatory environments. This allows Valero to reallocate capital to its Gulf Coast operations, where utilization rates remain strong.
• Marathon Petroleum (MPC): Focused on midstream infrastructure upgrades and capital returns, leveraging its robust Gulf Coast logistics network to maintain margin stability.
• Phillips 66 (PSX): Prioritized renewable transitions and regulatory preparedness, positioning itself for long-term resilience amid evolving energy policies.

These strategies underscore a sector-wide shift toward asset optimization and regional specialization. Gulf Coast-focused refiners, in particular, are better positioned to benefit from the current margin environment, as their operations align with the U.S.'s largest refining capacity and export hubs.

Near-Term Risks and Long-Term Opportunities

While the structural tightness in diesel markets supports margin resilience, investors must remain cautious about near-term headwinds:

• Refinery Maintenance Schedules: Gulf Coast outages during Q3 maintenance periods could temporarily strain supply.
• Crude Price Volatility: A rally in crude prices, as seen in June 2025, could compress refining spreads.
• California's Capacity Crisis: Planned refinery closures in the state are expected to reduce West Coast refining capacity by 17% by 2026, increasing reliance on imported fuel and creating localized volatility.

However, these risks are counterbalanced by long-term tailwinds:

• Global Refining Capacity Slowdown: New refining capacity additions have dropped from 1.2 million barrels per day in 2023–2024 to 500,000 barrels per day in 2025–2026. This structural underinvestment will prolong margin pressures.
• Export Demand Persistence: Strong demand from Asia and Europe for U.S. diesel is expected to continue, supported by low global stockpiles.
• Regulatory Tailwinds: Companies preparing for renewable transitions, like Phillips 66, are likely to gain first-mover advantages in the evolving energy landscape.

Investment Implications and Strategic Recommendations

For investors, the key lies in identifying refiners and energy infrastructure firms best positioned to capitalize on the Gulf Coast's resilience and global diesel demand. Here's how to approach the sector:

1. Gulf Coast Infrastructure Plays: Companies like Kinder Morgan (KMI) and Magellan Midstream Partners (MMP) benefit from the region's high utilization rates and export capabilities. These firms are less exposed to the margin pressures facing East Coast refiners.
2. High-Capacity Refiners with Cost Advantages: Valero and Marathon Petroleum, with their Gulf Coast-centric operations and disciplined cost structures, are well-positioned to sustain margins.
3. Renewable Transitions with Downstream Synergies: Phillips 66's focus on renewable fuels and regulatory preparedness offers a hedge against long-term energy policy shifts.

Conversely, investors should exercise caution with East Coast refiners and those with exposure to California's aging infrastructure. The Bayway refinery's 59% utilization rate, for instance, highlights the fragility of this segment.

Conclusion: A Sector at a Crossroads

The U.S. refining sector is at a critical juncture. While diesel shortages and structural tightness are driving near-term margin resilience, the long-term outlook hinges on strategic positioning and adaptability. For investors, the Gulf Coast's operational strength, global export demand, and underinvestment in refining capacity present a compelling case for selective exposure to energy equities.

As the Federal Reserve monitors refinery utilization as an inflationary signal and the EIA releases further data in late July, the sector's trajectory will remain a key barometer for energy markets. In this environment, patience and precision in portfolio construction—favoring Gulf-focused refiners and infrastructure players—will be the difference between capturing upside and falling victim to volatility.