Why oil prices have defied US$200 forecasts despite Hormuz closure

A CURIOUS thing happened to the price of crude oil after the outbreak of the Iran war – it has not skyrocketed despite the closure of the Strait of Hormuz and the US naval blockade. 

Brent crude, the global benchmark, was trading at about US$96 a barrel on Wednesday (Jun 3). This price is well below the dire forecasts of US$200 expected by analysts when the US and Israel struck Iran on Feb 28.

One reason is that there was an oil glut before the war. In January, Brent was trading at about US$66 a barrel. Furthermore, when the war broke out, many barrels of oil were already being shipped to their destinations. 

The second factor is quick action by the International Energy Agency (IEA), which organised the release of 400 million barrels of oil from the strategic reserves of its member nations. That’s more than twice the volume released after the onset of the Ukraine war. 

About 250 million barrels from the IEA members’ inventories flowed into the market by the end of April. This has ameliorated the loss of about 13 million barrels a day from the closure of the strait.

Third, there was a flood of supply from the US, Canada, Brazil and Guyana, among other countries. 

North American shale production needs prices above US$65 a barrel to turn a decent profit. The relatively higher oil price now has triggered a US shale oil boom – crude exports rose to a record 6.44 million barrels a day in April, according to Reuters. The Iran war has resulted in something of a bonanza for US oil producers, if perhaps unintended. 

Gulf oil not replaceable

None of this is to argue that the world is about to decisively shift away from oil produced in the Gulf. 

Given the proximity of the region to countries such as India, Pakistan and Bangladesh, importing oil from the Gulf remains their most optimal option. 

Moreover, many of these countries’ refineries are set up to process West Asian crude. The oil that used to flow through the Strait of Hormuz is a type rich in distillates such as diesel and jet fuel. 

Shale crude, which is produced in the US, is lighter and not a suitable replacement for those refineries. That predicament also holds true for much of South-east Asia as well as countries including Japan and South Korea.

The absence of China

Amid this disruption to oil supply, China has shown that it can maintain the stability of its energy reserves. Predictions that China will be adversely affected by the closure of the Strait of Hormuz seem overwrought in hindsight. In fact, China is weathering the supply disruption well.

While there has been speculation from think tanks about the source of China’s oil stockpile, there is little concrete information.

The absence of China in the global oil market is likely the final deciding factor for current manageable price levels. 

For the moment, global oil supply and demand seem to have settled in a precarious balance. How long that will last is anyone’s guess.