For more than three months, oil market participants have hoped that the Middle East conflict would be resolved any day now, while about 13 million barrels per day (bpd) have been wiped off global supply due to the closed Strait of Hormuz.
The oil futures market has been mostly guided by sentiment and traders’ hopes of an imminent peace deal – as U.S. President Donald Trump has been touting for weeks – with oil prices increasingly disconnected from the reality on the ground, or more precisely, in storage tanks.
Disconnected
The reality is that global oil stocks, including those in the United States, are plummeting as governments draw on strategic reserves to offset part of the massive losses of supply from the Middle East.
Each day that passes without normalized traffic through the Strait of Hormuz is further draining stocks, which top industry officials warn are on track for critically low level within weeks.
Cargoes would still need weeks to reach buyers even if the Strait of Hormuz reopened unconditionally today to free traffic, which isn’t the case with Iran’s demands in the negotiations with the U.S. to have operational control over the Strait. Related: Kuwait Offers First Crude Cargoes to Asia since Iran War Started
Of course, most oil flows could return if tanker owners and operators are willing to risk venturing into and out of the chokepoint, knowing that any peace deal could quickly unravel with one Israeli strike in Lebanon or one “I’ll blow them up” post about Iran by President Trump.
Depleted
Many traders appear unfazed in the face of the 13 million bpd supply loss, as they still hope for a quick resolution to the conflict – for over three months now – and bet on a gusher of oil supply when the Strait of Hormuz reopens.
In reality, even if the Strait reopened today, supply would take weeks and even months to reach customers, leaving a large gap in supply at the start of the peak summer demand season.
So far, the oil market has relied on oil on water, de-sanctioned Russian crude (and for a month even unsanctioned Iranian crude, too), and drawing on stocks to fill the gap. The market has also been lucky that China had amassed an estimated more than 1.2 billion barrels of oil in commercial and strategic reserves before the war, and its imports have collapsed with oil prices at $100 a barrel or more.
These buffers are being exhausted every day that traffic through the Strait of Hormuz is nearly halted, and we are approaching the tipping point soon, analysts and industry officials warn.
In the May monthly report, the International Energy Agency (IEA) said that global oil supply declined by a further 1.8 million bpd in April, taking total losses since February to 12.8 million bpd.
“Mounting supply losses from the Strait of Hormuz are depleting global oil inventories at a record pace,” the IEA said, adding that 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 is certainly also keeping prices from spiking to record levels, but this could soon remain the only buffer that could cap price gains.
Inventories are set to reach “rock bottom” within weeks, and the paper market could catch up with the worst supply disruption in history.
In the United States, stocks of crude and petroleum products had plunged to 1.53 billion barrels as of May 29, per EIA data, the lowest level in weekly ending stocks since 2004.
U.S. gasoline inventories are plummeting, and so are inventories at Cushing, the delivery point for WTI futures.
Many traders choose to ignore warnings from analysts and from the chief executives of both Chevron and Exxon that inventories are so low that oil prices are weeks away from spiking if traffic through Hormuz remains mostly choked.
“We’re approaching unheard of inventory levels. I mean, really, really low levels,” Neil Chapman, Exxon’s Senior Vice President, said at the Bernstein 42nd Annual Strategic Decisions Conference at the end of May.
“I think dated Brent, most people with a model would say dated Brent will shoot up once you get to that really low inventory level, up to $150, $160 — the models would tell you that.”
Chevron’s CEO Mike Wirth said on the same conference, “The buffers and the shock absorbers are being steadily drawn down and the ability for the market to absorb this imbalance is drastically diminished today versus where we started and over the next few weeks, we’re likely to see those pressures flow through more directly to physical prices, and there’s more upward pressure that I would expect as we get into June and certainly into July.”
Unknown
With inventories depleting at a record pace, demand destruction could soon remain the only shock absorber, insufficient to stop an oil price spike within weeks without at least a partially normal resumption of traffic at Hormuz.
The biggest unknowns are whether the U.S. and Iran could achieve a breakthrough in negotiations after months of impasse, and when China will return to the market. Beijing in May started tapping its huge reserves, keeping price gains limited.
The global, including Chinese, stock draws are finite and the futures market could soon start to reflect the true magnitude of the supply loss, against traders’ stubborn hopes of an imminent peace deal.
By Tsvetana Paraskova for Oilprice.com
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