One of the more confounding aspects of the war in the Middle East is the rate at which the oil market has changed since the US and Iran agreed their 60-day ceasefire.
Oil prices are almost back to their pre-war levels, with Brent crude trading around $US73 a barrel, and the volume of ships passing through the choke point of the Strait of Hormuz has almost normalised. The greatest oil shock in history seems to have passed with only fleeting effects.
Below the seeming calm of oil prices that have retreated from their highs approaching $US120 a barrel and the return of traffic to the strait, however, are a lot of moving parts that make it difficult to predict whether the current appearance of normalcy can be sustained.
For a start, the partial cessation of hostilities – Iran fired on two vessels last week – isn’t a permanent end to the conflict, which could flare up at any moment even though it is obvious that Donald Trump, having failed to achieve any of the objectives targeted at the start of the war, has no appetite for a resumption of the conflict.
There’s the existence of the mines Iran laid in the strait that will have to be cleared which, given that Iran itself seems to have only the fuzziest idea of where they are, could take months.
Iran also remains adamant that it will maintain control of the strait – never previously closed – and may impose charges on vessels transiting it in future.
There’s also going to be a permanent risk premium associated with transiting the strait – a premium that isn’t reflected in current oil prices – now that Iran has demonstrated its ability to close it.
That will deter Middle Eastern producers from relying on the strait. New pipelines that bypass the strait will take time to build.
Insurance costs will also remain significantly higher than their pre-war levels.
It used to cost about 0.25 per cent of a vessel’s value to ship products through the strait. That soared to 10 per cent at the height of the war, but still ranges between 3 and 8 per cent, or from about $US3 million ($4.4 million) to as much as $US8 million per shipment for the largest oil tankers.
Nevertheless, there are reasons, or at least explanations, for why oil prices dropped so quickly and sharply once the ceasefire was agreed.
A lot of ships and an enormous volume of oil were trapped in the Persian Gulf by the war. More than 1.3 billion barrels was held out of the market.
Now, those ships are exiting the gulf – most of the resumed traffic, which is running at about half pre-war levels, is one-way – and bringing that trapped oil back into the market. That’s a big one-off boost to supply.
Last week about 7 million barrels a day of oil and refined products flowed through the strait. While that’s a long way short of the 20 million barrels a day that was exiting the gulf pre-war, it’s oil that wasn’t available to the market until now.
As part of the ceasefire deal, the US has lifted its blockade of Iranian ports and its sanctions on Iran’s oil exports, which adds to the rebound in previously frozen supply.
At a broader level, when the war started the world was awash with oil, with supply outstripping demand.
The OPEC+ cartel had begun bringing back production that it had previously cut into a market where demand was relatively soft within a global economy where China and America’s economic growth rates were slowing. That created a buffer of supply as the war unfolded.
While the war cut off most of the 20 million barrels a day of supply that transited the strait, the Saudis and the United Arab Emirates, which have pipelines that bypass the strait, boosted the volumes exported via those pipes.
US and Russian producers rushed to exploit the higher prices – the US has been exporting oil at record rates – and, co-ordinated by the International Energy Agency, IEA member countries agreed to the release of 412 million barrels of oil from their strategic reserves.
While it took a while for those releases to build, the US alone added about 1.2 million barrels a day to the market in May from its reserve, which is now at its lowest level in more than 40 years.
Inventories, whether at sea, or in refineries or, in the case of the US, at the Cushing hub for its onshore oil producers, have been run down substantially, aiding the supply-demand balance.
There’s also been significant demand destruction, with some estimates that it could be as much as 5 million barrels a day.
Consumers and businesses have responded to the price signal of spiking oil and gas prices by reducing their consumption. There’s been a surge in purchases of electric vehicles. In some countries, particularly within Asia, hardest hit because of its reliance on oil and gas, there’s been a resurgence of coal.
Most particularly, China’s imports of oil have plunged. According to Bloomberg, it imported about 40 per cent less oil in May than its 2025 monthly average.
China stopped exports of refined products, accelerated its shift towards electrification, may have called on its massive strategic reserve of oil and may have run down the stocks at its refineries. Its economy has been weakening, which may have been another factor.
China’s is a command economy, with a greater ability to simply dictate energy consumption than Western economies.
In trying to work out whether the big falls in oil prices from their wartime peaks are likely into be sustained, there needs to be some assessment of the sustainability of the influences that have driven the prices down.
On the supply side, if the ceasefire holds and morphs into a longer-term deal that keeps the strait open, much of the lost volume – albeit probably not all – should return. Existing pipelines will be expanded and new ones built to reduce the risks the war revealed.
Middle Eastern producers – OPEC – will restore production and probably increase it to try to compensate for their lost revenues. The UAE, having quit OPEC in the midst of the war, has made no secret of its desire to free itself of OPEC’s production quotas and increase its output significantly.
With global refinery inventories and US stocks at Cushing heavily depleted, an inevitable need to rebuild the IEA members’ strategic reserves that were deployed during the war and some level of the diminished demand returning at the lower price levels, overall demand is also going to increase, even though some of the price shocks from the interruptions to supply are still flowing through to end product markets and economies.
That bounce back in demand ought to put a floor under oil prices, although whether it is outmatched by the returning supply isn’t knowable at this point.
It is difficult, however, to believe that a global oil shock of this magnitude could lead to the market functioning as if nothing had happened, particularly as the war has fundamentally changed the status quo in the Middle East and created risk premiums that never previously existed.
Predictions at the height of the war that the oil prices could hit $US200 later this year now appear most unlikely, but, even if hostilities don’t resume, the situation in the Middle East remains volatile and unpredictable, the oil market remains fragile and the current near risk-free pricing of oil at odds with the levels of risk and uncertainty.
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