The World Is Burning Through Its Oil Safety Net
Global oil inventories have fallen at a record pace during the Iran war
An underappreciated surplus of crude oil, sloshing around storage tanks and aboard ships, cushioned the global economy when the Persian Gulf closed 2½ months ago.
That excess supply is now dwindling at a record pace, with oil executives and analysts predicting that a harsh reckoning is set to upend the relative calm in energy markets. Acute shortages of key fuels and soaring prices could emerge within weeks if the Strait of Hormuz remains shut.
The drawdown in private storage and government strategic reserves along with a fall in demand due to the higher prices, has bought time and prevented oil prices from exploding. But it has left little margin for error in the months ahead.
“You can only decrease consumption so much, and when inventories run out, they are going to run out,” said Ellen Wald, senior fellow at the Atlantic Council’s Global Energy Center. “At some point the market is going to collide and prices are going to shoot up.”
Global oil inventories—which include onshore tanks and oil floating on tankers at sea, and are a measure of the slack in energy markets—have fallen at a record pace since the start of the war. They plunged by 250 million barrels over March and April, according to the International Energy Agency, a Paris-based club of energy consuming nations. That is equal to around 2½ days of global oil use.
The runway to avoid reaching critical levels—known as tank bottoms in industry parlance—is vanishing rapidly.
In a report titled “The illusion of plenty,” JPMorgan Chase estimated that if the strait remains blocked, stockpiles in a group of wealthy nations could plunge to “operational stress levels” early next month and to system-straining “operational floor level” by September. The bank said it doesn’t expect inventories to actually reach those levels because history suggests demand would be curtailed first.
The implications of an oil supply shortage are vast. Prices at the gas pump are already touching their highest levels in years in the U.S. and could shoot higher when stocks run low. Airlines are reorganizing flights to adapt to potential shortages of jet fuel. Central bank decisions over whether to raise interest rates will depend in large part on whether oil markets remain well supplied.
The chief executive of Saudi Aramco, Saudi Arabia’s state-owned oil company, said this week that global stockpiles for refined products such as gasoline and jet fuel could reach “critically low levels” ahead of the summer driving and travel season.
In a possible sign the supply worries are bleeding into markets, oil prices jumped Friday, with global benchmark Brent crude rising at one point more than 3% to $109 a barrel. That’s still below its closing high of $118 at the end of March.
The oil market’s saving grace was the remarkable surplus it carried into the conflict, which cushioned the blow far better than analysts predicted when the Strait of Hormuz first closed. Both Iran and Russia had millions of barrels of oil floating at sea, looking for buyers. U.S. Treasury waivers on sanctions of Russian oil unleashed a gusher of supply onto the market.
Another major part of the emergency backstop is coming from the U.S. and other Western governments. The 32 member nations of the IEA deployed roughly 164 million barrels through May 8, helping to offset the 10 million barrels a day lost in the Gulf.
The IEA expects its members to release an additional 210 million barrels of government stocks through the end of July.
But releasing stocks isn’t the same as replacing supply. It shifts the shortage problem from today into the future, when governments and companies eventually will have to rebuild depleted reserves. The IEA estimates that replenishing the cumulative deficit, including strategic reserves, would require roughly an extra one million barrels a day of supply for three years.
As a result of the inventory depletion, U.S. stocks of diesel are likely to fall below 100 million barrels, the lowest level since 2003, by the end of May, according to consulting firm Eurasia Group. Even sharper declines are hitting Asia, the region most reliant on Persian Gulf exports before the war.
Based on current supply trends and domestic inventories, countries like India, Thailand and Taiwan are rapidly approaching critical scarcity levels of refined products such as naphtha, fuel oil and diesel, according to estimates by Goldman Sachs.
Some countries in the region have imposed fuel-saving measures, cut refinery runs or restricted product exports to conserve domestic supplies.
To be sure, surplus inventories aren’t the only factor. Falling oil consumption—known in economic parlance as demand destruction—is doing some of the balancing work. The IEA expects global oil demand to contract this year, with the sharpest hit in the second quarter, as high prices, fuel-saving measures and weaker economic growth weigh on consumption.
Demand destruction, however, at a large enough scale, will eventually translate into a hit to economic growth.
The drawdown of excess oil inventories has eased the immediate market panic. The premium commanded by physical oil barrels over futures has fallen in recent weeks after shooting up earlier in the conflict when refiners and traders bid up every cargo available. According to the IEA, the premium of North Sea Dated physical crude over the Brent futures price fell from as high as $35 a barrel in mid-April to around $3 a barrel earlier this month.
That spread is important because it measures how urgently buyers need real barrels now, compared with later delivery. Its narrowing suggests the market has moved from panic to managed scarcity—not that the underlying shortage has disappeared.
“The urgent, immediate grab for physical cargoes has died down,” said Hamad Hussain, commodities economist at Capital Economics. “However, we are drawing down those stocks pretty quickly, and as a result, prices will have to rise as a direct consequence of that.”
He expects that if the strait remains closed and the inventory drawdown continues, oil prices could top $130 to $140 a barrel next month.
Even if Washington and Tehran reach a swift deal to reopen the Strait of Hormuz, the physical flow of Gulf oil won’t immediately bounce back, analysts say. Clearing possible mines, repairing infrastructure and untangling maritime logistics will push the resumption of normal shipping traffic back by at least two to three months, the IEA said.
“Supply is unlikely to recover in the next few weeks or next few months, even if the strait opens tomorrow,” said Tamas Varga, analyst at London-based oil broker PVM.