The good news: the Strait of Hormuz has reopened after Iran and the United States signed a memorandum of understanding this week.
The bad news: it may already be too late.
Oil stopped leaving the Middle East for almost four months. In total, the world lost 1.15 billion barrels of oil supply during the war, according to analysis firm Kpler.
This left the oil market in a fragile situation and quickly approaching a breaking point. The International Energy Administration’s strategic reserves are at their lowest levels since 1990. America’s emergency reserve is at its lowest level in 43 years. And commercial inventories have reached operational pressure levels.
“Do you want to see chaos?” asked Donald Trump at the G7 summit in Versailles on Wednesday. “Our reservations last about four weeks.”
Trump is right. But the reopening of the strait this week may not be able to get oil out of the Persian Gulf fast enough to prevent crude oil stocks from effectively running out.
Oil prices may have to rise again.
The turning point
The oil market certainly believes that Trump’s timing is perfect. Prices, as he predicted, have fallen sharply in recent days as the memorandum of understanding with Iran has been drafted and entered into force.
Brent prices began to fall after the ceasefire announcement in mid-April, falling from a wartime peak of $126.41 to less than $80 per barrel today.
The fall in oil was sustained by the historic oversupply of crude before the war, which ended up cushioning the biggest supply shock ever. But that excess evaporated and quickly turned into a worrying deficit.
An aerial view shows a crude oil storage facility in Cushing, Oklahoma, on June 9. Dave Ruff/CNN
World oil reserves have fallen sharply by 190 million barrels in recent months. A critical plant in Cushing, Oklahoma, that distributes fuel throughout the United States, has reached its operating pressure level — the equivalent of when the coffee drops below the spout of the machine and you have to tilt the container to get what’s left. Much of what accumulates at the bottom of oil deposits is unusable material, which makes it difficult to maintain pressure in pipes to send oil to customers.
This isn’t just happening in Cushing — storage facilities around the world are nearing a tipping point.
“There will come a time when it will not be possible to get oil,” Trump said on Wednesday, warning of a possible “economic catastrophe” if the strait had not reopened. He also said this could lead to comparisons with Herbert Hoover, the former president associated with the start of the Great Depression.
Higher prices
Reopening the strait does not immediately solve the global inventory problem. It just starts the process of normalizing the oil flow.
The strait will have to be demined, empty oil tankers will have to return to the area, production will have to resume and the oil will have to begin a slow journey to its destination. None of this will happen quickly — it is a process that the oil industry believes could take months for the flow to return to something close to “normal”.
Until the market truly returns to normal, the system will continue to depend on these reserves.
This is why several industry analysts believe that oil prices have fallen too low and that the market is underestimating the risk of depletion before deposits are replenished.
“The market has jumped seven steps ahead of the current situation,” said Helima Croft, head of global commodities strategy at RBC Capital Markets. “Everyone thinks, ‘This is over!’ But there’s a big logistical challenge to get back to where we were.”
A driver fills up a vehicle with regular gasoline at a Shell gas station in Hercules, California, on May 21. David Paul Morris/Bloomberg/Getty Images
When enthusiasm for the reopening of the strait subsides, market fundamentals should prevail again, causing oil prices to rise again.
“Regardless of what happens in the coming weeks in the Strait of Hormuz, North American consumers will see higher prices this summer,” said Matt Smith of Kpler. “It hasn’t happened yet because of the optimism surrounding the deal. But market forces will have to come into play.”
The math confirms: even if the global oil market started producing almost 5 million barrels more than consumption, as predicted by the International Energy Agency, it would take around a year to recover the 1.15 billion barrels of lost supply.
“At some point, physical barrels really matter,” said Dan Pickering. “If these barrels are lost, that has an impact.”
Lower prices
But the market is not always logical.
Traders see the flow of oil about to return — especially from OPEC countries lacking liquidity and interested in increasing production. This new reality will make it very difficult to reverse the market trend, argued Jay Hatfield, CEO of Infrastructure Capital Advisors.
And the perspective is important: the world was so supplied with oil before the war that it remains, to some extent, protected from the huge drawdown of stocks.
“We had a big margin of safety, and we’ve already used it up,” said Vikas Dwivedi, global oil and gas strategist at Macquarie Group. “We are below where we were last year — but not by much.”
For example, diesel reserves in the United States are at their lowest level since 2003, but are only 12.4% below the average over the past five years. Gasoline reserves are just 5% below their level a year ago.
Stock risk is real, but bullish investors are giving it too much weight, argues Dwivedi.
“If you are an oil trader at a refinery and your job is to buy oil, during the crisis you had to make 10 calls to get oil. Now you make 5 or 6,” said Dwivedi. “In the coming weeks, sellers will start contacting you and saying: ‘I have oil, do you want to buy it?’”
