Although oil markets often quickly get over geopolitical threats, the recent escalation in the Middle East appears to be different this time, with the price of Brent crude rising nearly 8% to around $78 a barrel since the new crisis with Iran erupted over the weekend.
Although the market usually prices in risks and then outpaces them, analysts warn of two scenarios that could lead to a longer and more severe oil shock.
According to what the Wall Street Journal reported, the first scenario is a long-term disruption to the passage of oil tankers through the Strait of Hormuz, through which about 20 million barrels pass daily, equivalent to a fifth of the world’s production.
As for the second scenario, production facilities or oil infrastructure in the region are exposed to direct strikes, affecting the surplus production capacity in Saudi Arabia and the UAE.
Worst case scenario: Prices above $130
Clinton Siegel, a senior researcher at the Center for Strategic and International Studies, believes that the most dangerous scenario is that vital export facilities in neighboring countries are exposed to direct Iranian strikes, especially those that are close to Iranian weapons range and are difficult to repair quickly.
Siegel estimates that the realization of this scenario could push prices above $130 per barrel, the level witnessed by the markets after the Russian invasion of Ukraine.
Why is the situation different this time?
Historically, pessimistic forecasts have not been met. No significant disruption to traffic in the Strait of Hormuz has been recorded since the 1980s, and attacks targeting Saudi Arabia’s oil infrastructure in 2019 did not cause widespread damage.
But Bob McNally, president of Rapidan Energy Group, points out that markets have lived through “seven years of a false shepherd scenario,” making them less sensitive to recurring threats.
However, the current escalation represents a completely different level. Washington, according to Siegel, is not only pressuring the Iranian regime, but is moving in the direction of overthrowing it, which means that Tehran “no longer has any reason not to use its most powerful weapons, including its ability to disrupt oil and gas markets.”
Iran has already launched attacks on 3 commercial ships near the Strait of Hormuz, and also targeted the largest Saudi oil refinery.
Clear View Energy reports that Iran may not be able to completely close the strait, but it is capable of making passage more dangerous through attacks, maritime harassment, or planting mines.
“All Iran needs to do is make it so risky that insurance companies and operators will refuse to go through,” McNally said.
If the strait is disabled, the capacity of alternative pipelines is insufficient. The International Energy Agency estimates the available capacity at only 4.2 million barrels per day, while five times this number passes through Hormuz.
Global spare capacity is also becoming less. OPEC+ countries have increased their production over the past two years, which has led to a decline in the surplus. Although it announced an increase of 206 thousand barrels per day at the beginning of April, the RBC Capital Markets report indicates that actual production will be lower due to the lack of real production capacity among some members.
Can China absorb the shock?
Over the past months, China has purchased large quantities of discounted and pre-sanctions oil, and kept a portion of it in stock. Morgan Stanley analysts estimate that it may slow its purchases if prices jump, providing some balance.
But the opposite scenario exists. The escalation of the conflict may push Beijing to increase storage rather than reduce it.
As for the floating stock of oil subject to sanctions, Goldman Sachs estimates that it amounts to about 375 million barrels, but benefiting from it depends on the willingness of China and other countries to challenge the Trump administration’s restrictions.
American shale oil… is not reserve energy
Although the United States is the world’s largest oil producer, shale oil is not considered spare capacity because it needs several quarters to significantly increase production, according to Goldman Sachs, not 30 days as spare capacity definitions stipulate.
In contrast, strategic stocks can relieve pressure, but in limited capacities.
The US emergency reserve can pump 1.4 to 2.1 million barrels per day, while members of the International Energy Agency may contribute an additional 5.2 million barrels per day.
But all of this is still small compared to the 20 million barrels per day that pass through the Strait of Hormuz under normal circumstances. US stockpiles do not exceed the equivalent of 20 days of domestic consumption.
Oil is a deterrent for both parties
Ahead of the midterm elections, US President Donald Trump does not want to see gasoline prices rise. In contrast, Iran cannot afford to lose its oil revenues.
But the escalation of events has shown that both parties are willing to bear greater risks than the markets expect, making oil prices hostage to every new development.
