The oil market may be sleepwalking into a significant move higher if the Strait of Hormuz remains blocked beyond March.
The massive loss of supply from the Middle East has already reverberated through Asia, which depends on oil and gas from the Gulf and which is already rationing fuel, banning exports, and paying hefty premiums for any crude that could replace the sour Middle Eastern grades that are trapped by the de facto closed Strait of Hormuz.
Oil traders and speculators – those who haven’t fled yet the extremely volatile crude futures trade these days – seem to be hanging on to every word of U.S. President Donald Trump. But his messaging has been chaotic, with threats of obliteration, proposals of peace plans, and insistence that the U.S. is negotiating with Iran.
The market has reacted to all these with violent swings up or down. Between Monday and Wednesday, prices slumped by 10% amid market hopes that some negotiations are indeed taking place and could yield results.
Speculation vs Fundamentals
However, the reality looks quite different from what the crude futures market is projecting.
Physical supply, of the magnitude of millions of barrels per day, is being curtailed in the Middle East as producers are forced to reduce output because oil has no way out of the region. Shortages are already hitting Asia and will soon spread to Europe, too.
But the paper market looks complacent, probably also because the supply crunch will be last felt in the United States. The U.S. benchmark, WTI Crude, has widened the discount to the international benchmark, Brent Crude, to more than $10 per barrel—a gap not seen in years. Currently, Asian refiners do not need most of the U.S. crude as they cannot efficiently process the light sweet oil from the shale fields. Asia wants sour barrels of the type it has been importing from the Middle East for decades.
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As a result, WTI may keep trading at huge discounts while Brent and Middle Eastern benchmarks are set to climb higher. The longer the Strait of Hormuz blockage persists, the more severe the upward pressure on the Brent and Middle Eastern crude prices will be.
“You’ve seen Asia absolutely fighting for every barrel there is in the world,”
Amrita Sen, founder of consulting firm Energy Aspects, told The Wall Street Journal.
If the Strait of Hormuz remains shut for a few more weeks, the price of Brent Crude will eventually catch up with the surge in physical crude from the Middle East, according to the analyst.
Oil prices could soar to $150 per barrel or more if the Middle East war continues until the end of March, Kpler said last week.
“With this huge outage of supply it is just a matter of time where prices really catch up with the fundamentals here and we just see how bad things are,” Amena Bakr, Kpler’s Head of Middle East and OPEC+ Insights, told CNBC International last week.
We are now nearing the end of March, the conflict doesn’t appear to be very close to resolution, and the Strait of Hormuz remains shut to most tanker traffic except at Iran’s discretion for “friendly” countries, including China and some other nations in Asia.
Oil Shortages Start to Emerge
As of March 20, more than 130 million barrels of crude were already lost from the Middle East, and cumulative disruptions could exceed 250 million barrels by the end of March, 400 million barrels by the middle of April, and 600 million barrels by the end of April if flows don’t resume, Kpler said in a note on Friday.
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Short-term fixes, including SPR releases and sanctions relief, “can only delay, not offset, the growing structural deficit,” Kpler’s analysts reckon.
By March 20, Middle Eastern oil producers had already shut in 10.7 million barrels per day (bpd) of output. These could rise to as much as 11.5 million bpd by late March and remain at that level throughout April if the situation in the Strait of Hormuz does not improve, according to Kpler.
The production cuts are not only driven by export constraints—several refineries in the region, including in Saudi Arabia and Bahrain, have been hit and forced to shut down or reduce runs.
The trapped supply in the Middle East is forcing Asian refiners to pay huge premiums for crude that could replace some of the supply loss, with the most suitable grade from Norway, Johan Sverdrup, being bid at record-high double-digit premiums over Dated Brent.
Refiners in Asia are cutting processing rates due to a lack of crude, fuel prices are skyrocketing, and governments are implementing fuel-saving measures such as four-day work weeks, work from home, and extended national holidays. Many Asian countries are also banning exports of fuels, which ripples through the global fuel supply, especially in jet and diesel markets.
Europe could experience energy shortages before the end of April, Shell’s CEO Wael Sawan warned at the CERAWeek conference in Houston.
“South Asia was first to get that brunt. That’s moved to Southeast Asia, Northeast Asia and then more so into Europe as we get into April,” Sawan said earlier this week.
The longer the Strait of Hormuz remains de facto closed, the more severe the crisis will become.
“Ultimately, it matters little what narratives about a potential peace deal Trump puts forward,” Ole Hansen, Head of Commodity Strategy at Saxo Bank, said on Wednesday.
“The unfortunate reality remains that Iran holds the strategic leverage through its control of the Strait of Hormuz, allowing it to maintain economic pressure on both the US and the global economy.”
By Tsvetana Paraskova for Oilprice.com