Oil Market Loses Its Safety Net as Iran Conflict Reignites

The global oil market is much more exposed to the latest re-escalation in the Middle East, as most of the buffers that cushioned the initial shock of the Iran war are wearing thin and unable to prevent the next oil price spike. For weeks, market participants were too complacent that the U.S.-Iran memorandum of understanding would reopen the Strait of Hormuz and the oil flows would recover steadily by the end of the third quarter. The reality dawned on the oil market last week, when the re-escalation all but closed the Strait of Hormuz, again, and the surge of tankers evacuating from the Persian Gulf abruptly stopped. Oil prices hit $90 per barrel early on Monday as supply concerns resurfaced with the Strait essentially closed again and tanker traffic at multi-month lows to the level from before the MoU, which appears to be all but dead now. Prices could go much higher if the renewed conflict drags on for a few more months, as the world has now drained a lot of the buffers that had kept oil surges in check between March and May. Related Houthis Declare Naval Blockade on Saudi Arabia as Red Sea Crisis Deepens Oil prices did hit $100 per barrel, and even higher at the end of the first quarter and early in the second quarter. But releases from strategic reserves globally, and reduced demand in Asia with switching to coal, fuel savings measures, and China slashing its crude oil imports to a decade low, helped cushion the price impact from a closed Strait of Hormuz. The new closure of the key oil chokepoint comes as the world has exhausted the buffers on which it relied in the second quarter. Drained strategic and commercial inventories in many key oil-consuming economies, including the United States, are setting the stage for further oil price rallies during the busiest oil demand season. The U.S. Strategic Petroleum Reserve SPR, for example, has been drained to the lowest level since 1983, following a 172-million-barrel release in the second quarter. As of July 10, the SPR held 316.5 million barrels in the underground salt caverns in Texas and Louisiana, which was the lowest weekly ending stocks of crude oil in the reserve since the first half of 1983, per the latest data from the Energy Information Administration EIA. It's not only the U.S. emergency reserve that's been drained to the lowest in decadesinventories have crashed globally as governments and refiners used stockpiles to offset part of the massive supply loss from the Middle East. Even China, which is believed to have amassed 1.3 billion barrels of crude oil in stockpiles before the Iran war, has started to tap these stocks as it slashed imports to the lowest since 2018 amid high prices and constrained flows from the Middle East. The initial shock from the war was largely absorbed by slashed oil demand in Asia, higher production in the Americas, and inventories. "The estimated market deficit of about 4.0 million barrels a day in MarchMay was met almost entirely by drawing down global stocks, including commercial inventories in China and strategic reserves," economists at the International Monetary Fund said in a note last week. However, "As tensions flare again in the Strait of Hormuz, that room is now smaller and shrinking further as spare capacity has been deployed, demand has compressed, and inventories have been drawn down," the IMF warned. The fund's commodities experts noted that the buffers that helped prevent a larger price spike in the second quarter are now running low. "Unless inventories are replenished, the world will start from a weaker position when the next shock comes," they said. The market is now more vulnerable to the next shock as "the issue for the oil market is that SPR releases, which have offered some relief during the war, are set to cease around the end of this month," ING's commodities strategists Warren Patterson and Ewa Manthey wrote in a note early on Monday. By Tsvetana Paraskova for Oilprice.com