The Oil Market's Fragile Balance
For more than three months, oil market participants have held onto the hope that the Middle East conflict would be resolved soon. However, the closure of the Strait of Hormuz has resulted in a loss of approximately 13 million barrels per day (bpd) from global supply. This situation has led to a significant disruption in the oil market, with traders and investors hoping for an imminent peace deal.
Disconnect Between Sentiment and Reality
The oil futures market has been largely influenced by sentiment and the hope for a quick resolution to the conflict. However, the reality on the ground tells a different story. Global oil stocks, including those in the United States, are plummeting as governments draw on strategic reserves to offset the massive supply losses. Each passing day without normalized traffic through the Strait of Hormuz further drains these stocks, which industry officials warn could reach critically low levels within weeks.
Even if the Strait of Hormuz were to reopen today, it would take weeks for cargoes to reach buyers. Iran’s demands in negotiations with the U.S., particularly regarding operational control over the Strait, complicate this scenario further.
Supply Challenges and Market Buffers
Many traders remain unfazed by the 13 million bpd supply loss, still hoping for a quick resolution to the conflict. However, even if the Strait reopened today, it would take time for supply to reach customers, creating a large gap during the peak summer demand season.
To fill this gap, the oil market has relied on oil on water, de-sanctioned Russian crude, and drawing on existing stocks. China, with its estimated 1.2 billion barrels of oil in commercial and strategic reserves, has also played a crucial role. However, these buffers are being exhausted daily as traffic through the Strait of Hormuz remains nearly halted.
Industry Warnings and Analyst Concerns
The International Energy Agency (IEA) reported in its May monthly report that global oil supply declined by an additional 1.8 million bpd in April, bringing total losses since February to 12.8 million bpd. The IEA warned that mounting supply losses from the Strait of Hormuz are depleting global oil inventories at a record pace. Observed global inventories, including oil on water, were drawn down by 250 million barrels over March and April, or by 4 million bpd.
Demand destruction has helped keep prices from spiking to record levels, but this may soon be the only buffer available to cap price gains. Inventories are expected to reach “rock bottom” within weeks, and the paper market could catch up with the worst supply disruption in history.
U.S. Inventory Levels and Industry Warnings
In the United States, crude and petroleum product stocks had plunged to 1.53 billion barrels as of May 29, according to EIA data—the lowest level in weekly ending stocks since 2004. U.S. gasoline inventories are also declining, along with inventories at Cushing, the delivery point for WTI futures.
Industry leaders like Exxon’s Senior Vice President Neil Chapman have warned about the approaching inventory levels. He stated that dated Brent could shoot up to $150 or $160 once inventory levels reach such lows. Chevron’s CEO Mike Wirth echoed these concerns, noting that the ability of the market to absorb the imbalance is diminishing rapidly.
Uncertainties and Future Outlook
With inventories depleting at a record pace, demand destruction could soon be the only shock absorber, insufficient to prevent an oil price spike without a partial resumption of traffic at Hormuz. The biggest unknowns are whether the U.S. and Iran can achieve a breakthrough in negotiations after months of impasse and when China will return to the market.
Beijing has started tapping its huge reserves, helping to keep price gains limited. However, global stock draws are finite, and the futures market could soon reflect the true magnitude of the supply loss, despite traders’ hopes for an imminent peace deal.
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