Why the Real Oil Crisis Hasn’t Started Yet

It’s been a month since the Strait of Hormuz was effectively closed, and the “shockwave” of higher prices and economic disruption may finally be emanating past the Indian ocean.

While global oil prices have risen since the U.S. and Israeli attacks on Iran that began on February 28, the Brent and West Texas Intermediate benchmarks ($114 and $105) are still well short of all-time highs, despite the fact that the world is experiencing the largest physical disruption to the oil industry in modern history.

“With each passing day, an estimated ~11-12 million barrels per day of oil, condensate, and refined products is not reaching global markets,” Jefferies analyst Lloyd Byrne wrote in a note to clients over the weekend. That’s out of around 100 million barrels per day of global oil production, and about what two Indias would consume. During the 1970s oil shocks, the supply shortage was roughly 4 million barrels per day.

Because demand for liquid fuels is relatively inelastic (your commute doesn’t get shorter when oil prices rise), the price increases necessary to induce the “demand destruction” that brings supply and demand back into balance is quite high. Analysts such as Commodity Context’s Rory Johnston argue that blocking the strait could send oil to $200 a barrel or higher.

That global cataclysm hasn’t happened yet. But if this goes on much longer, the chances it does only get higher and higher.

That’s because, oil analysts say, the world has so far been able to draw down stocks of oil that aren’t being freshly pumped out of the Middle East and shipped from the Persian Gulf. These include 400 million barrels that are being withdrawn from the world’s strategic energy reserves, as well as the release of Russian and even Iranian oil from sanctions, allowing it to flow into the broader economy.

“The oil market did not underreact. It just had buffers,” the energy consulting firm Rystad said in a note last week.

But, Rystad oil analyst Paola Rodriguez-Masiu wrote, “those buffers are now largely consumed, and the system that absorbed the initial shock is not the system operating today.”

Rystad estimates that 500 million barrels total have been “lost” from the market, about equal to the reserve release and de-sanctioning. That means the market will have to begin to make due with less oil.

Rystad is not the only firm calling a turning point. “The cumulative losses are now large enough to matter in end-use markets,” Morgan Stanley analyst Martijn Rats wrote in a note to clients Monday.

The market’s other buffers were time and space: After traffic through the strait stopped, oil continued to arrive in refineries all over the world on tankers that already were on the water before the attacks began.

“The time lag in global arrivals also helps explain why the physical market is only now starting to bite,” Rats wrote.

JPMorgan analyst Natasha Kaneva has described a kind of rolling shortage emanating from the Persian Gulf, based on how long it takes tankers to arrive. Oil takes anywhere from 10 to 20 days to arrive at ports in Asia from the Persian Gulf, meaning that customers there are “already feeling the squeeze as pre-closure cargoes have largely dried up.” While for the Atlantic Coast of the United States — which imports only around 250,000 barrels per day from the Persian Gulf, out of around 6 million annual imports to the U.S — it takes a month to six weeks for tankers to arrive after they set out.

Already, Rats wrote, some 2.5 million barrels per day of refining capacity in Asia is offline because refineries can’t get their hands on sufficient oil. In Australia, 600 gas stations “have run out of at least one type of fuel,” the country’s energy minister told parliament last week. In South Korea, Finance Minister Koo Yun-cheol told local media that the country could impose nationwide restrictions on driving if crude gets above $120 a barrel, Reuters reported.

After Asia comes Africa, especially East Africa, where in Kenya, fuel started running short last week. Shell Chief Executive Wael Sawan warned attendees at the CERAWeek energy conference that shortages could hit Europe in April.

Then comes the United States. The West Coast is effectively the farthest eastern point of the Asian fuel market. There, gasoline has already hit $5.88 a gallon, compared to the $3.99 national average and $4.64 a month ago. But while so far the shock is being experienced as higher fuel prices for transportation, Kaneva warns that in California, it is “likely to evolve into a physical supply challenge by late April and May, as replacement options dwindle and competition for suitable crude intensifies.” That raises the alarming prospect of gas stations running empty.

The Trump administration has also been actively intervening to keep prices low, whether through coordinated releases from the Strategic Petroleum Reserve or well-timed announcements of supposed breakthroughs in negotiations or partial ceasefires.

But the effectiveness of this jawboning may have been as much due to the delay of the oil shockwave as to anything the president did or didn’t say or do.

Despite President Trump telling the Financial Times on Sunday that Iran had already undergone “regime change” after the death of much of its pre-war leadership and that “the negotiations are going very well,” both Brent and WTI are up on the day Monday.

“The global oil system today is not the system that absorbed the first two weeks of the shock,” Rats wrote. “Spare capacity is trapped behind Hormuz. Inventories are lower. Freight is less flexible. Products are tighter. The distance between a manageable disruption and a disproportionate price move has collapsed.”