Oil Prices Fail to Reach Record Highs Amidst Largest Supply Disruption in History

Global Oil Markets Defy Grim Forecasts, Prices Remain Below $100 a Barrel

For decades, oil traders, executives, and analysts have warned that closing the Strait of Hormuz would be a global economic catastrophe. It's now been more than three months since the waterway was effectively blocked, creating the worst supply shock in modern history. However, a slew of workarounds is keeping crude oil below $100 a barrel, defying many of the industry's grimmest forecasts for prices as high as $200.

A combination of record US exports, a sharp and unexpected slowdown in Chinese demand, and a steady trickle of crude still finding its way through the strait has helped absorb much of the shock from the loss of more than 10 million barrels a day of Middle Eastern supply. A pre-war surplus has also eased the blow.

US oil production has boomed to record highs in recent years thanks to the shale revolution that began over a decade ago, turning the country into a net exporter of crude and refined product. The abundance of domestic energy has allowed President Donald Trump to make geopolitical decisions and moves that would've once been considered unthinkable — not just starting a war against Iran, but also the seizure of Venezuelan President Nicolas Maduro.

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The Trump administration has made other strategic moves to help stabilize markets. Notable among those has been a waiver for some sanctioned Russian oil, making it easier for Indian processors, in particular, to boost purchases. Russian flows to India, the world's third biggest importer of crude, averaged about 1.76 million barrels a day in May, 63% higher than in February.

Global inventories are drawing down at a record pace, leaving the market increasingly vulnerable to fresh disruptions. With spare supplies dwindling, even relatively small outages could trigger violent price spikes. "Each week that goes by, the system is tightening by 70 to 80 million barrels. You can't do that forever," said Greg Sharenow, who helps manage nearly $24 billion as head of Pacific Investment Management Co.'s commodity portfolio investment team.

The twin forces of US exports and depressed Chinese buying are in part why the world's most important physical crude price, Dated Brent, has retreated below $100 a barrel after surging to a record above $140 a barrel in the early phase of the war. The most recent expiry period — the vital window in which real-world and futures prices converge — showed little indication of a supply shortage.

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However, the limits of some of the workarounds are coming into focus. Overall oil inventories in the US shrank to the lowest level in more than two decades last week. Emergency reserves have little oil to spare, and fuel stockpiles are facing critical lows as peak summer demand months approach.

"We're not capable of sustaining these exports," said Pimco's Sharenow, adding that inventories at the critical storage hub in Cushing, Oklahoma, are approaching operational lows. At the same time, domestic refiners are running their plants harder than usual to meet fuel demand and competing for barrels, sending the premiums for US crude delivered in Asia higher relative to available Middle Eastern supplies, according to traders.

Many traders see China's eventual return to pre-Iran war oil purchasing rates as the key to predicting when oil prices finally lurch higher. The voracious appetite of the world's largest crude importer — over 10 million barrels a day since the start of the war in Ukraine — has been curbed for now. That drop-off has come in part as the nation stopped growing its giant strategic stockpile, which has ballooned in recent years.

"The extent of which has taken most of the market by surprise," said Warren Patterson, the head of commodities strategy for ING Groep NV in Singapore. China's backing off from the crude market has played a crucial role in attempting to rebalance the global market, which has helped cap oil prices.

Persian Gulf oil producers had workarounds that quickly saved the market in the early days of the war. Saudi Arabia's East-West pipeline shipped millions of barrels a day to the Red Sea, while the United Arab Emirates has been piping barrels to the port of Fujairah outside the gulf. There's also been a trickle of vessels willing to transit the strait, either as part of government-to-government deals, risk-taking enterprise, or, more recently, with help from the US.

Still, transits have plunged to two or three every day compared to nearly 100 prior to the conflict, according to shipping tracking data. Visibility on commercial shipping through the waterway is limited by ongoing GPS jamming and tracking disruptions.

"As a bare minimum of what counts as a 'meaningful recovery' I think that we would need to see a full week averaging 20 ships per day — and that's not realistic until there is a durable US-Iran settlement, which keeps getting pushed out," said Pavel Molchanov, an analyst at Raymond James.

Another factor keeping a lid on prices has been Trump's relentless jawboning, making it hard for even the most bullish traders to hold long positions for prolonged periods of time. Open interest in Brent crude futures is the lowest since August as elevated market volatility forces traders to roll back risk exposure.