The likelihood of a swift reopening of the Strait of Hormuz is diminishing, yet international oil prices have not surged to levels matching the mounting supply risks. Analysts are warning that the current disconnect between oil prices and geopolitical dangers may be unsustainable over the longer term.
Brent crude futures closed more than 8% lower last week. This followed signals from the United States that the chances of reaching an agreement with Iran and reopening this critical global energy passage were increasing, prompting markets to price in a potential supply recovery prematurely. However, a deal has not been reached, and the outlook for negotiations deteriorated further over the weekend. Iran is demanding that the US meet several conditions before the Strait of Hormuz can be reopened. Meanwhile, US President Donald Trump has signaled a shift in strategy. On Monday, he put forward a sweeping new set of demands, requiring Iran to "pay reparations for all the lives lost and those severely injured due to roadside bombs and many other conflicts." This latest turn has set the two nations on a new path of confrontation. Trump stated these demands would be "firmly included in all future negotiations," but they are almost certain to be rejected by Iran, which is itself seeking compensation for damage caused by the war that began on February 28th.
In response to the stalled negotiations, Brent crude futures rose to near $88 per barrel in early Tuesday trading, up from around $83 at the end of last week. However, this price remains significantly below the highs of over $100 per barrel touched in July and the peak of more than $110 per barrel seen in May.
Market Awaits a Deal, But Supply Risks Are Mounting
The recent relative calm in oil prices has been primarily supported by market expectations of a temporary solution. Energy traders had drawn confidence from signs that Iran and Oman were continuing discussions about establishing a temporary shipping corridor through the Strait of Hormuz. Concurrently, the perceived likelihood of further military escalation between the US and Iran has decreased. Modupe Adegbembo, an economist at Jefferies, said in a CNBC interview on Monday, "Traders currently believe we can reach an agreement, even if it's just a stopgap measure. The deal might not be perfect, but it could be something that allows more oil and goods to move through the Strait of Hormuz." However, Adegbembo noted that this market reaction might be temporary. She indicated that if the current situation persists into the end of this week or next, oil prices are unlikely to remain so subdued.
Kieran Tompkins, Senior Climate and Commodities Economist at Capital Economics, believes current low oil prices reflect investors weighing two scenarios. One scenario involves a rapid reopening of the Strait of Hormuz, with energy transportation gradually returning to normal. The other is a prolonged closure of the strait, leading to sustained global supply constraints. Tompkins said that if the stalemate continues, the market will have to price in a higher risk of long-term closure. He stated, "I would naturally expect near-term crude oil futures prices to rise, especially if the market's focus on the so-called 'tipping point' re-emerges." This "tipping point" refers to the stage where the market's capacity to absorb supply shocks by drawing down inventories is exhausted, ultimately forcing demand to decrease through higher prices to rebalance with limited supply. Tompkins suggested that if the Strait of Hormuz remains closed and OECD oil inventories continue to decline rapidly, the oil market could reach this tipping point around the start of the fourth quarter. Based on historical experience, this could correspond to oil prices in the range of $120 to $140 per barrel.
How Long Can Alternative Supply and Weak Demand Hold Up?
The market has been relying on several factors to buffer the risks from Hormuz, including alternative export routes, declining demand, increased production, and phased reductions in crude imports by major consuming nations. But analysts are beginning to question how long these factors can continue to support the market. Amrita Sen, founder and research director at Energy Aspects, told CNBC on Friday that China's reduction in oil imports in May significantly helped keep the market balanced. "China single-handedly balanced the market in May by cutting its oil imports," she said. However, as Chinese crude imports recovered in July and are expected to increase further in August, Sen believes this buffer is shrinking. "Crude oil prices cannot stay low forever," she stated. She noted that the market has recently been quick to price in the possibility of shipping resumption whenever there is any sign of a deal, without fully reflecting the reality of sustained supply constraints. One risk factor is the ongoing attacks on Saudi Arabian infrastructure by Iran-backed Houthi rebels. Saudi Arabia is a crucial source of supply for global oil market stability. Sen argues that from a supply and demand fundamental perspective, the crude oil market is actually presenting a more bullish pattern. "From a fundamental standpoint, the outlook for crude is more bullish," she said. If the Hormuz negotiations continue to stall, market expectations regarding the duration of the supply disruption may change, and the current oil price may need to reassess this risk.
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