There’s an increasing imbalance of global oil supply and demand as the war in the Middle East drags on. With global oil inventories depleting at a record rate to fill the gap, it could take months, if not years, to return the market to something resembling its pre-war state.
According to the International Energy Agency’s latest Oil Market Report, released this week, even if the war were to end next month, it would take until the final months of the year before supply recovered to the point where it could get close to meeting demand.
With inventories being drawn down so rapidly, that means more price volatility – and probably prices that remain higher for longer – even if the war, currently at a stalemate, were to end soon.
If the US is unable to devise a pathway out of the morass that its decision to launch the attack on Iran with Israel has created, then the gap between supply and demand will widen further, of course, prices will remain high, and oil shortages will continue to deteriorate.
Given that the impact of the war is already showing up in higher energy and food prices and spikes in inflation and interest rates around the world, the longer the war continues, the more destructive its economic effects will be.
In the US, for instance, data released this week showed consumer price inflation is up 1.4 percentage points since the war began. On Wednesday, US producer price data showed wholesale inflation leaped 6 per cent last month, its highest level since 2022, when Russia invaded Ukraine. The damaging effects of higher energy prices are steadily spreading deeper into economies.
Whatever the demand for oil might have been before the ill-thought-through assault on Iran, it will be materially lower in future.
On the IEA’s scenario – where the war ends next month – demand for oil would have been diminished by the war and the price moves and product shortages it has generated, but global supply will have contracted by far more.
The agency forecasts demand to fall by 420,000 barrels a day this year, to 104 million barrels a day, or 1.3 million barrels a day less than its pre-war expectations. For the June quarter, it sees a drop of 2.45 million barrels a day, with higher prices, a weaker global economic environment and demand-saving measures increasingly affecting fuel use.
Global oil supply, however, is projected to slump by an average of 3.9 billion barrels for the year, to 102.2 million barrels a day, providing flows through the Strait of Hormuz gradually resume from next month.
That global supply was 95.1 million barrels a day in April, or 1.8 million barrels a day lower in than in March and well below pre-war levels of nearly 108 million barrels a day. Since the onset of the war, total losses of supply are 12.8 million barrels a day, according to the IEA.
Even assuming the conflict does end imminently, the falls in supply relative to even diminished demand should mean oil prices will be materially higher heading into next year than their pre-war levels of just under $US70 a barrel.
The gap between supply and demand has been partially filled by a record 4 million barrels a day – or 246 million barrels in total, so far – drawdown of global oil inventories, including national strategic reserves. If the oil trapped on tankers in the Persian Gulf is excluded from the calculations, the reduction in the available global stocks is far greater.
The net impact of the supply/demand/inventories equation is that, even if the war somehow does end next month, the market will remain “severely undersupplied” until at least October, according to the IEA.
The longer the Strait of Hormuz remains closed, and the faster the inventories deplete, the more the gap between supply and demand will be reflected in even higher prices and product shortages.
The Persian Gulf producers have already lost about a billion barrels of supply because of the war and have had to shut in more than 14 million barrels a day of production, with the Saudis bearing the brunt of that lost output and revenue – even though they, and the United Arab Emirates, have redirected some supply to their export terminals on the Red Sea and Gulf of Oman.
Some of the lost production, but not nearly enough to offset the loss of Gulf supply, has been offset by an increase in supply elsewhere, particularly from the Americas – the US, Canada, Venezuela and Brazil – and from Russia. (Apart from the US waiving sanctions for Russian oil on the water, Ukrainian attacks on Russia’s refineries have reduced its ability to produce refined products for domestic consumption, creating pressure for increased exports).
Even if the war were to end within weeks, it will take time to clear the backlog of oil now trapped within the Strait of Hormuz. The waterway would need to be cleared of mines and there would be some complex and time-consuming scheduling before the 85 tankers can exit the strait and normal two-way traffic can resume.
It would also take weeks for the shut-in production to be brought back into the market and months, if not years, for the oil and gas industry infrastructure in the region damaged by Iranian retaliation to be restored to full operation.
Iran’s demonstrated ability to close the strait at will, and the prospect that it could charge tolls for safe passage, will also have lasting impacts. Global refineries outside the region – or customers dependent on Middle Eastern refineries for processed oil – will want to diversify their supply.
As was the case after the twin oil shocks in the 1970s, the experience will also create lasting structural effects on the demand side.
Already, there has been a discernible increase in demand for electric vehicles, increased interest in the electrification of transport fleets and in renewable energy technologies.
Whatever the demand for oil might have been before the ill-thought-through assault on Iran – which produced what should have been a foreseeable response, the closure of the strait – it will be materially lower in future.
That means, at some point after the war is over and after strategic and industry reserves have been replenished, it is probable that the world will be awash with surplus supply – a likelihood strengthened by the UAE’s recent exit from the OPEC+ cartel with its production constraints – and prices will eventually fall substantially.
For the moment, the producers, most notably those in the US, able to increase their production and ship their oil freely, are grabbing windfall profits.
In the longer term, those same producers may curse Trump and Israel’s Prime Minister Benjamin Netanyahu for triggering accelerating changes to their market that will permanently damage their margins, profitability and value.
In the meantime, of course, thanks to the Trump administration’s naive assessment of Iran’s likely response to the attacks, the rest of the world will live with the growing economic pain caused by its reliance on oil and gas, and the concentration of a significant proportion of global oil production in a single and volatile region.
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Stephen Bartholomeusz is one of Australia’s most respected business journalists. He was most recently co-founder and associate editor of the Business Spectator website and an associate editor and senior columnist at The Australian.Connect via email.