A dangerous new phase of war is breaking all the oil market’s constraints

Earthguardiansonline.com – The oil market has proven defiantly resilient, but that tenacity faces its biggest threat since the start of the Iran war. The energy industry’s remarkable workarounds to the world’s biggest-ever oil shock have insulated consumers from an inflation and affordability crisis. During the war, crude prices rose uncomfortably high, though they never approached the $128 a barrel level reached in 2022 or the all-time record of $146 a barrel just before the Great Recession of 2008.

But extraordinary pressure is building in the Middle East, and the new escalation could send oil blowing past those dubious milestones. “The conflict has entered a decidedly more dangerous phase,” said Helima Croft, head of global strategy at RBC Capital Markets. “It could shift the sentiment of ‘the market always finds a workaround’ camp.” On Thursday, oil topped $100 for the first time since May.

Gas prices are now solidly above $4, and diesel is above $5.20 a gallon. The bond market is signaling that it’s more concerned about an inflation problem now than at any point during President Donald Trump’s second term. Each of the factors that had prevented oil from surging over the past five months has either weakened or evaporated.

The high-oil-price monster is threatening to break through its restraints. Old story: Oil was bypassing the conflict zone through the Red Sea. New story: Oil is getting choked off at two crucial pinch points.

Iran’s attacks on oil tankers in the Strait of Hormuz have frozen most crude traffic through the crucial waterway. So the market got creative and piped around 7 million barrels of oil per day to the Red Sea that would normally have been destined for the Persian Gulf, according to JPMorgan. Now, those pipeline workarounds are vulnerable, noted Capital Economics.

The Houthi blockade of the Bab-al-Mandeb strait has blocked another exit point for roughly 5 million barrels per day of Saudi oil. The Saudis can reroute that oil north through the Suez Canal, but the largest, fully laden oil tankers can’t get through that way because of depth constraints, noted Natasha Kaneva, head of global commodities strategy at JPMorgan. Even if the oil is placed on smaller tankers, heading through the Mediterranean and around Africa makes a typical four-week trip into an eight-week one.

Old: Insurers were charging ships a hefty war premium. New: Policies will no longer cover ships that pay Iran a toll. Vessels looking to exit the Strait of Hormuz during the war had to pay high insurance rates – but at least they could get insurance.

Lloyd’s Market Association, a group representing maritime insurance agents, called into question on Thursday whether ships exiting the strait could get policies going forward. Iran has said it plans to re-impose tolls of $1 to $2 per barrel of oil, generating millions of dollars per vessel for the regime. That poses an unacceptable risk to insurers, LMA said in a newly drafted clause for shipping policies: Paying a toll to Iran is illegal, because it violates US sanctions.

Paying a toll can void a vessel’s entire insurance policy, creating an extraordinary risk for shipping companies. With Iran insistent that it has the right to attack ships that try to exit without paying, ships have effectively no path out of the strait. Old: The oil conflict was isolated to the Middle East.

New: Russia is a big part of the energy problem. Ukrainian drone attacks on Russian refineries and the Caspian Pipeline Consortium terminal in the Black Sea have created a significant new problem for the global energy market. The attacks created a massive fuel shortage in Russia, leading the country to ban diesel exports.

That took a huge amount of fuel off the market: Before the ban, Russia exported 800,000 barrels of diesel per day – 12% of the world’s diesel shipments, according to Andy Lipow, president of Lipow Oil Associates. Ukraine’s Black Sea attacks have also hurt crude supply at the worst possible time. The pipeline doesn’t output a ton of oil, but it threatens to remove 1.7 million barrels per day from the global oil market just as millions of barrels via the Strait of Hormuz workarounds are getting closed off.

Old: The world was oversupplied with oil. New: Crude inventories are reaching critically low levels. The most fundamental difference between the start of the Iran war and the current situation: the amount of oil in global storage.

Crude inventories were at historic highs before the war but have tumbled by 1.3 billion barrels over the past five months, according to Dan Pickering, chief investment officer at Pickering Energy Partners. That’s a particular problem for the United States: The US Strategic Petroleum Reserve has been drawn down by 116 million barrels since the spring to its lowest level since 1983. It has just another 60 million barrels to expend before it hits its congressionally mandated floor.

US commercial inventories are also nearing their operational minimums, at which point physics no longer allows oil companies to force oil through the pipelines with gravity alone. It’s a reality that Trump in June said could create an “economic catastrophe” that would earn him comparisons to Depression-era President Herbert Hoover. And there’s no rescue coming from oil trapped in the Strait of Hormuz this time.

More than 200 million barrels of oil escaped the strait in June during the brief ceasefire agreement. Now, only 44 vessels are sitting inside the strait, compared to 97 just before the Memorandum of Understanding, according to Naveen Das, an analyst at Kpler. Old: China has enough oil in storage to weather the crisis.

New: China can’t hold out forever. Demand for oil collapsed over the past five months, mostly because China had the foresight to stockpile oil before the war so it wouldn’t have to import as much at high prices. But China can’t possibly rely this much on its inventories for much longer.

It has about three to four months before it needs to increase its imports, Kaneva said. So now, the oil market is in a race against time. Prices remain relatively subdued considering its tight fundamentals.

Demand destruction is still mostly winning out over supply constraints. But prices will continue to climb if the status quo remains, according to Daan Struyven, head of oil research at Goldman Sachs. He believes oil could test those 2022 highs above $120 a barrel by October.

Croft thinks the threat is even greater: If a full regional war breaks out, oil could set a new record above $150 a barrel.