Oil Retreats but Supply Shock Drives Huge Weekly Gain as U.S. Diesel Shatters Record

Oil prices retreated on Friday as traders weighed signs of possible diplomacy in the Middle East, yet crude remained headed for a weekly gain exceeding 9 percent.

The powerful advance reflected mounting fears that attacks near critical shipping corridors could inflict prolonged disruption on global energy supplies.

Brent crude futures fell $2.46, or 2.29 percent, to $105.17 a barrel by 11:33 a.m. in Houston.

United States West Texas Intermediate crude dropped $2.44, or 2.38 percent, to $100.04 a barrel.

Both benchmarks had climbed to their highest levels since the middle of May earlier in the session.

Their direction changed after the Financial Times reported that regional foreign ministers were seeking a temporary agreement with Iran to manage shipping through the Strait of Hormuz.

The reversal followed a dramatic rally on Thursday, when Brent and WTI each surged more than 6 percent after shipping attacks escalated across the region.

By Friday, traders were reassessing how much immediate supply risk should remain embedded in prices.

"The things that were causing the panic yesterday are easing today," said Phil Flynn, senior analyst with the Price Futures Group.

"The question is will the market remain calm over the weekend? That's when things seem to happen."

Reports of potential negotiations concerning the future of Hormuz delivered the strongest blow to bullish sentiment.

Still, the possibility of further attacks left the market vulnerable to sudden price swings before the weekend.

"Some headlines of possible new talks in the Middle East are weighing moderately on oil prices today," said UBS energy analyst Giovanni Staunovo.

He said risks remained tilted toward higher prices in the near term, while warning that intense volatility would probably continue.

Fresh concern also emerged around Saudi Arabia after satellite images showed smoke near the kingdom's East West Pipeline on Thursday.

The pipeline has become increasingly important because it allows Saudi crude exports to bypass the Strait of Hormuz.

Saudi crude supply plunged by 2.3 million barrels per day during August, reaching 6 million barrels per day, according to the International Energy Agency.

That was the lowest level in more than three decades, with the agency citing attacks against Saudi energy installations.

Pressure also intensified near the Bab el Mandeb Strait, another vital passage for global trade.

Four Yemeni government sources told Reuters that the Iran aligned Houthis reached the island of Perim on Friday, potentially strengthening their control around the strategic shipping route.

Iran said it attacked 10 ships near the Strait of Hormuz on Wednesday after the United States struck five Iranian oil tankers.

The Islamic Revolutionary Guard Corps warned that it would intensify its response if additional attacks occurred.

Preliminary ship tracking information showed vessel transits through Hormuz falling to seven on Thursday from 11 a day earlier.

Before the Iran war began in late February, the strait handled about 125 commodity vessels and roughly one fifth of daily global oil and liquefied natural gas supplies.

The energy shock is also spilling into monetary policy.

Two European Central Bank policymakers indicated on Friday that further interest rate increases could become necessary if war driven energy inflation spreads into other prices across the euro zone.

Fuel markets are already displaying severe stress as disruption from the Iran war combines with Ukrainian attacks on Russian refineries.

GasBuddy said the national average United States diesel price exceeded $6 a gallon for the first time on Thursday, marking a record high.

"Refined products, particularly diesel, are feeling a one two punch right now," said Tim Waterer, chief market analyst at KCM Trade.

He said Gulf shipping restrictions and Russian refinery outages could keep diesel and other refined products rising faster than the broader crude market.

Commerzbank responded to the tightening outlook by lifting its year end Brent forecast to $85 a barrel from $75.

It also raised its diesel forecast to $1,200 a ton from $950 and increased its jet fuel projection to $1,230 a ton from $980, reflecting the mounting strain across refined product markets.