The Strait of Hormuz has been blocked for over three months, severing more than 10 million barrels per day of Middle Eastern crude supply, creating the most severe oil supply shock in modern history. However, Brent crude has retreated from its record high above $140 in the early days of the conflict to below $100, failing to meet the industry's pessimistic forecasts of up to $200. "People thought it would be much worse," said the U.S. President on Friday, "Today I see $96 a barrel; people thought it would go to $300." The conflict has now lasted nearly one hundred days. On the 5th, the U.S. President declared that Iranian military capabilities had been "completely destroyed." Yet, on the 6th, U.S. forces conducted new airstrikes on parts of Iran, prompting retaliatory missile strikes by Iran on U.S. military facilities in Kuwait and the Fifth Fleet's base in Bahrain. Amid intermittent fighting and negotiations, a series of emergency measures are enabling the global oil market to absorb this supply shock with unexpected resilience. Maria Angelicoussis, CEO of the world's largest Greek shipowner, the Angelicoussis Group, stated: "The world has shown surprising resilience after more than three months of conflict. Commodity prices have risen 50% to 60%, Asian LNG prices are up 90%, but they haven't reached the sky-high levels I, at least, expected."
Three Forces Keeping Oil Prices in Check
From the demand side, as the world's largest crude oil importer, China's May crude imports plummeted by nearly 40% compared to last year's average, according to Vortexa data. This decline is sufficient to offset one-third to one-fifth of the supply lost due to the war. Contributing factors include China halting the recent years' trend of increasing its strategic petroleum reserve stockpiles, coal-based chemicals replacing some petrochemical capacity, and booming electric vehicle sales suppressing gasoline consumption. Estimates from Kpler and Energy Aspects indicate that China's refinery throughput in May-June fell to around 13 million barrels per day—a level last seen in early 2020, compared to last year's average of 14.8 million barrels per day. Warren Patterson, Head of Commodities Strategy at ING, noted, "China's significant retreat from the crude market has played a key role in the global market rebalancing, helping to cap prices."
While demand contracted, the supply side also demonstrated unexpected resilience—primarily influenced by the United States. Thanks to the shale oil revolution launched over a decade ago, the U.S. is now a net exporter of crude oil and petroleum products. Its ample domestic energy resources are a key reason for the U.S. administration's confidence in engaging in the conflict. Since the war began in late February, the U.S. has further assumed the role of the world's most important swing supplier. In May, U.S. crude and fuel exports exceeded last year's average by over 2 million barrels per day. The U.S. administration pledged a release of 172 million barrels from the Strategic Petroleum Reserve (SPR), with execution speed exceeding expectations—in one week last month, SPR releases reached 1.4 million barrels per day, with nearly half shipped to Europe and other overseas destinations. Washington also played another card: granting partial exemptions to sanctions on Russian crude, making it easier for India to increase purchases. In May, Russia's exports to India, the world's third-largest crude importer, averaged 1.76 million barrels per day, 63% higher than in February. Alternative export routes provided additional buffers. Saudi Arabia moved crude to the Red Sea via the East-West pipeline, and the UAE transported crude via pipeline to the port of Fujairah outside the Persian Gulf. Governments also coordinated a historic joint release of strategic reserves, and pre-war market supply overhangs absorbed some of the shock. Although the number of commercial vessels transiting the Strait has plummeted from nearly 100 per day pre-conflict to 2-3, a small number of vessels continue to pass through via government-to-government deals or increasingly covert means. According to an official familiar with U.S. Central Command operations, nearly 1,000 commercial vessels have transited the Strait in the past two months.
Buffers Are Depleting
These emergency measures have stabilized oil prices, but they are themselves being consumed. Global oil inventories are declining at a record pace. Greg Sharenow, Head of Commodities Portfolio Management at Pimco, which manages nearly $24 billion in assets, offers a blunt warning: "Every week, the system tightens by 70 to 80 million barrels. This cannot go on forever. Within the next few months—to be generous—you will be facing a system that may lose its resilience because the buffers have been severely depleted."
The U.S. domestic situation is also tight. Last week, total U.S. petroleum inventories fell to their lowest level in over 20 years. Inventories at the key storage hub in Cushing are nearing operational minimums, the strategic reserve is nearly depleted, and fuel inventories are at critically low levels as the summer driving season approaches. Domestic refineries are running at high utilization rates to meet demand, competing with exports for crude supplies, which has pushed up the premium of U.S. crude over Middle Eastern crude in Asia. "We don't have the ability to sustain these export levels," Sharenow said.
Will Prices Soar Next?
Ongoing calls for peace talks from the U.S. administration have, to some extent, capped oil prices. Open interest in Brent crude futures has fallen to its lowest level since last August. Severe market volatility has forced traders to reduce risk exposure, and price plunges triggered by peace expectations have pushed many long positions to the sidelines—operating only with small positions and short timeframes. However, the prospects for peace talks remain unclear. Raymond James analyst Pavel Molchanov pointed out that the "minimum threshold" for resuming Strait shipping is at least 20 vessels per day for a continuous week—"This is unrealistic before a lasting U.S.-Iran reconciliation, and the timing for that keeps being pushed back." An article in Time magazine highlights an awkward reality: even if negotiations succeed, the best outcome would merely be the reopening of the freely flowing Strait as it was before the war, plus a nuclear agreement unlikely to be more robust than the 2015 Iran nuclear deal—after a hundred days of war, the best ending is a return to the starting point.
Most traders view the timing of China's return to its pre-conflict crude purchasing levels as a key variable for oil price direction. But even if answers are found to the above questions, the market still faces an unavoidable deficit. Tom Baker, Head of Vitol's Bahrain company, the world's largest independent oil trader, said at a conference this week: "Essentially, everyone is expecting the solution to be just around the corner. But no matter how quickly capacity is restored, you still face a deficit—call it what you will—of 1 billion barrels of oil that has already vanished."
Global spare supply is rapidly diminishing. According to Sharenow's assessment, buffers could be exhausted within the coming months—at which point, even a relatively small supply disruption could be enough to trigger a sharp price spike.
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