If the Strait of Hormuz is opened immediately oil prices will remain in the US$80 to US$100 per barrel range but low inventories will not buffer supply shortages, risking a price hike to US$120 to US$150.
There is justified concern about oil prices and it makes sense to try to understand what is happening and what might happen for the rest of the year.
The oil price is driven by three main factors: So far this year there have been three broad phases. The first is the pre-conflict period from January to the start of the Middle East war on Feb 28. This saw a build-up of tension and rhetoric that created risk which the oil markets built into the spot price, causing it to rise by around 15%. The second phase is the conflict period itself.
Precise news was scarce during this period, except for the reality of military action. In particular, the impact of bombing on oil facilities and supply infrastructure was largely unknown as was how long military action would last. Oil prices spiked by 80% at their peak around the 8 April “ceasefire” announcement. The third phase is the post-“ceasefire” period which we are now in.
The oil price has fallen by around a third since then as the shock of the conflict receded and the realities of the supply situation became clearer. This reality is that while there is uncertainty and sporadic fighting, the risks of a new all-out conflict have receded. Oil facilities and supply infrastructure are largely intact but have been shut down due to the chokepoint at the Strait of Hormuz which is stopping oil supplies from leaving the region.
Additional supplies have been made available in the form of 400 million barrels of inventory from 32-members of the International Energy Agency and the impact of price hikes and oil shortages has caused a slowdown in demand which has helped moderate prices. This is the market doing its job. The big question now is: What will happen to oil prices for the rest of the year?
The main concern is not so much the price of oil but the physical stocks. Inventories are at record low levels globally and finding supplies is increasingly difficult even if the price premium can be accommodated. Unless the Strait of Hormuz is opened immediately the low inventories will not buffer supply shortages and there is a risk of another price hike to US$120 to US$150 per barrel. Even if the chokepoint is opened the return to business-as-usual will be delayed.
Crude oil in transit still takes five to six weeks to get to destinations in Europe and Asia and then must be processed and refined. Oil facilities that have been closed take three to six months to reopen to full capacity to fill new containers for shipment and again this must be processed and refined for sale in the industrial and consumer market.
So while opening the chokepoint will ease concerns, it can be 12 to 18 months at least before there is a return to normal and prices are likely to remain in the US$80 to US$100 per barrel range even in the best of circumstances. The good news is that in the long-term, oil reserves are still plentiful and new sources, including the release of Venezuelan crude, will provide supplies for decades to come.
The shock of the current conflict could be a catalyst to the shift to renewables, biofuel blends and changes in behaviour but the danger is that a return to US$60 per barrel will be a return to normal uncertainty and risk. The views expressed are those of the writer and do not necessarily reflect those of FMT.
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