If this keeps up, oil is going to $200. (Nope) … Gas will hit a record, too. (Wrong) … And after the Strait of Hormuz finally reopens, oil will return to pre-war prices next year – at the earliest (Survey says: ❌).
Oil industry analysts (and, ahem, at least one CNN journalist) are eating a lot of humble pie lately.
Despite the biggest oil supply shock in history, oil prices in recent months never approached their record set in 2008. Gas and diesel prices didn’t surpass their 2022 highs. And, as President Donald Trump predicted, oil prices have, in fact, fallen “like a rock” after the United States reached an agreement with Iran.
How were all the experts so wrong?
The oil supply shock was unprecedented, so history was no help. But good, old-fashioned capitalism turned out to be very helpful.
The oil market is incredibly complex and significantly more flexible than even the most knowledgeable experts anticipated.
“Markets tend to solve problems more efficiently than expected,” said Peter Taylor, head of commodity strategy at Macquarie Group.
Don’t pop the champagne just yet, though: This oil story isn’t quite over.
Supply
Iran’s closure of the Strait of Hormuz cut off around 13 million barrels of oil per day, roughly a fifth of the world’s supply. All told, the global economy will lose 1.6 billion barrels of oil supply between February and August, according to JPMorgan.
All of that oil stuck behind a barrage of missiles and sea lanes choked with mines led a number of respected oil analysts to predict that oil prices would surge as high as $150, or even $200 by the summer. But Brent crude never settled above $115 and US oil didn’t even get to $113 a barrel.
Record supply was a significant contributing factor: The world entered the Iran war with 407 million barrels of useable oil in storage, according to JPMorgan. That provided a significant cushion for prices.
So too did a record 400-million-barrel release from the International Energy Agency’s strategic petroleum reserves – a supply boost that’s still underway. And Trump’s decision to lift sanctions on Russian and Iranian oil also added hundreds of millions of barrels to the market.
“The market repeatedly adjusted in ways that kept prices from moving materially higher,” said Natasha Kaneva, head of global commodities strategy for JPMorgan – one of the few analysts who correctly predicted prices would average only around $100 during the spring.
But Kaneva said she was surprised how much supply emerged from the supposedly closed Strait of Hormuz over the past month or so: Dozens of ships turned off their transponders and sneaked out of the Persian Gulf, taking around 2 million barrels of oil per day with them.
Combined, those supply boosts made the shock considerably more manageable for the market to absorb.
Demand
On the other side of the supply-and-demand scale, consumers’ appetite for oil fell substantially more over the past few months than just about anyone predicted. Between February and August, fallout from the Iran war will have destroyed 800 million barrels of oil demand, JPMorgan estimates.
We mostly have China to thank. With its enormous pre-war stockpiles and massive shift to coal-firing energy plants during the war, demand in China fell by 2.6 million barrels per day, according to Kpler. The country also has made a massive push to switch to electric vehicles, which reduced Chinese oil consumption by 1 million barrels per day, the International Energy Agency estimates.
Although oil companies still needed to use up a significant portion of their inventories during the supply shock, the demand destruction kept crude stockpiles from running dry.
Whether the oil market balance was achieved by reducing inventories or demand may not sound important. But for prices, the distinction makes an enormous difference, Kaneva noted.
When stockpiles fall, prices typically surge as refiners compete for scarce supply. But when demand sinks, prices tend to tumble along with it.
Production
Another significant factor is the surprising ramp-up in production during the war, particularly from Brazil and Venezuela. The United States didn’t increase output all that much, but it became a supplier of last resort to help fill the gap left by the Middle East. That helped resolve Europe’s emerging jet fuel crisis and Australia’s diesel shortage.
A big reason prices have tumbled so much in recent days and weeks is the expectation that the increase in production isn’t going to reverse itself once the Strait of Hormuz reopens – releasing about 93 million barrels of stranded crude, according to Kpler.
If anything, the world could get way more supply than it needs.
OPEC member countries that reduced production because there was nowhere to put their oil are expected to start flooding the market.
“Saudi Arabia’s economic recovery from the Iran war will be turbo-charged by an increase in oil output,” said Jason Tuvey, emerging markets economist at Capital Economics. He also predicts the UAE’s exit from OPEC means that it will raise its own oil output sharply in the coming weeks and months.
Despite expectations that production ramp-up could take several months, it could actually happen significantly faster than that, Macquarie’s Taylor believes.
“Complexity bias has set the narrative that normalization of the oil market could take a great deal of time,” Taylor said. “We disagree.”
Fast or gradual, the IEA expects the production ramp-up will generate a global oil surplus of about 5 million barrels of supply per day next year.
But…
Supply may be higher than expected. Demand may be lower. And an enormous amount of oil may be about to flood the market. But the problem isn’t solved – not yet, anyway.
Inventory levels at Cushing, Oklahoma, the pipeline crossroads of the United States, fell just below 19 million barrels last week, the lowest since August 2014. That’s below operational stress levels, where it becomes difficult to generate enough pressure to deliver oil through the pipelines to refineries that need it.
With prices back at pre-war levels, the market is certainly anticipating that US inventory levels won’t present a serious problem. But an Iran agreement that allows those barrels to come back into stockpiles, and actually refilling the inventories, are two separate things.
“Getting the barrels back is a different challenge from reaching a deal,” noted Alan Gelder, head of macro oils at Wood Mackenzie.
Gelder anticipates 90% of pre-war production could return within six months but getting back to normal could take “considerably longer.”
Meanwhile, China and other countries that dug deep into their inventories will probably want to replenish them, Oxley noted. That could restore a lot of demand later this year and into 2027.
That’s why Oxley expects most of the good news has been factored into the oil market, and prices don’t have much more room to fall from here.
But this market keeps defying expectations.
How does a oil trader manage all of these surprises?
“Be nimble,” said Taylor.
