With oil markets nearing the danger zone, a US-Iran deal can’t come soon enough | Heather Stewart
IIt won’t be too soon for oil markets, which are approaching a dangerous turning point, with a US-Iran deal about to be reached three months after the launch of Donald Trump’s Operation Epic Fury.
After Iran responded to the US and Israeli attack by closing the Strait of Hormuz, the cost of a barrel of crude oil (for immediate purchase) rose by approximately $100 in the spot market.
This price remains well below historical highs and markets may appear to have entered an uneasy stasis as it does not rise into the stratosphere.
But beneath the surface, each week that passes pushes energy markets closer to what economists call “nonlinear adjustment,” meaning chaos.
So far, several factors have helped ease potential supply constraints, including a record coordinated release of strategic oil reserves; Diverting some of the Gulf production to pipelines bypassing the Strait of Hormuz; and the rapid decline in imports to China, which some analysts believe may reflect Beijing reducing its stockpiles.
However, the International Energy Agency (IEA), whose director general Fatih Birol has been sounding the alarm from the beginning, said last week that oil stocks increased. sold out at record speed. And some analysts have warned in recent weeks that that point could be approaching quickly when it falls to crisis levels.
This could drive prices high enough to cause “demand destruction” (a pullback on consumption to meet limited supply) on a scale far more economically damaging than anything we have ever seen.
Hamad Hussain, who covers climate and commodity issues at consultancy Capital Economics, recently warned: “If the Strait remains effectively closed and commercial oil stocks in the OECD continue to decline at the same pace as in April, oil stocks could reach critical low levels by the end of June.”
He suggested this could push Brent crude oil prices to $130-140 per barrel; and face the risk of “more erratic and economically damaging disruptions to oil demand.”
His warning echoed earlier analysis by JP Morgan’s Natasha Kaneva, who said stocks in OECD countries could reach “operational stress levels” as early as next month.
“Long before the system is emptied, higher prices begin to outweigh demand,” he said. “Consumers are driving less, industry is cutting back on trips, airlines are cutting schedules, and refineries are reducing efficiency,” he added, describing it as a shift from a “managed” regulation to a “mandated” regulation.
Or as the IEA warns: “With global oil stocks already reaching a record high, further price volatility is likely to emerge ahead of peak summer demand.”
The United States has been relatively insulated from the impact of the oil shock as a net exporter of crude oil since the shale boom. But American consumers cannot be protected from rising global energy prices. Research by Prof Jeff Colgan of Brown University last week suggested that consumers have paid an extraordinary $40bn (around £30bn) in additional fuel costs since the war began, or a whopping $300 per household.
And the Washington-based Institute of International Finance (IIF) last week, in an edition of its regular capital flows report called The Long Tail of Shock, worried that disruption was now spreading far beyond oil markets.
“The first phase of the shock focused on the rapid repricing of oil as markets reacted to risks of disruptions in the Middle East and critical shipping routes. The second phase is more impactful as the adjustment spreads across LNG.” [liquid natural gas]Refined products, fertilisers, transport and industrial inputs have led to a wider deterioration in supply reliability and production efficiency, the IIF said.
The institute highlighted that oil prices, which tend to fall with each new rumor of a peace deal, may not have adequately demonstrated the severity of the broader disruption underway.
“Crude benchmarks may soften intermittently as recession fears rise or geopolitical tensions temporarily ease; LNG, fertilisers, freight costs and selected industrial inputs remain elevated as the broader issue is no longer just spot oil supply but the reliability and resilience of the global production system,” he said.
It is not yet clear whether any agreement will include a full reopening of the Strait of Hormuz once Tehran relinquishes control. But even if maritime traffic quickly resumes, the IIF predicts only “partial normalization”, with the energy system remaining “more tight and fragile than before the shock”.
In fact, by demonstrating that it is no longer willing or able to police free navigation in the Middle East’s waterways, the United States may have actually semi-permanently increased the prices of global commodities.
On the brink of crisis, governments in many countries implemented measures to restrict energy demand in order to limit the impact of the crisis on consumers. Forecasters have lowered expectations for GDP growth in oil-importing countries as higher costs hurt economic demand.
But if peace talks falter once again and weeks continue to pass without a solution, the oil market could enter a new, more volatile phase. In the short term, this could mean rising inflation and perhaps outright shortages of oil-based products. But over time, fear of recession can overcome these challenges.
Trump suggested he wasn’t considering the financial situation of ordinary Americans when negotiating with Iran. But its own citizens are not the only ones who have a stake in resolving this conflict: In increasingly fragile energy markets, even extending the talks for a few more weeks could have disastrous consequences.
