New York/London (CNN) — Sound familiar? A pause in fighting between the United States and Iran has given oil traders hope that a diplomatic resolution could restart the flow of oil traffic out of the Middle East.
Oil prices tumbled 8% Monday, on pace for crude’s biggest single-day decline since May 25.
The “news” that oil markets are trading on is thin at best: The Trump administration paused plans to escalate the war. And a lack of fighting this weekend suggested that maybe the two countries could return to the negotiating table.
This war has widened and has no easy solution. The United States lacks a clear exit strategy. Iran remains incentivized to exercise maximum control over shipping traffic entering and exiting the oil-rich region. Traffic through the Strait of Hormuz remains effectively halted, and significantly lower through the Bab-al-Mandeb strait – with oil tankers unwilling to risk taking on fire from the Iranians and Houthis.
Yet oil markets continue to have a kind of peace bias, with prices sinking on any sign of positive news. It happened in mid-April after a ceasefire was announced, and crude dipped below pre-war levels in June when Iran and the United States signed a short-lived Memorandum of Understanding.
The market’s resilience during the war has given traders good reason to keep a ceiling on crude prices, even if as the on-again, off-again conflict adds considerable doubt that the oil market will ever return to “normal.”
Low demand, high supply
Demand for oil has remained stunningly low over the past several months as the world adapted to losing around 13 million barrels of supply each day after Iran effectively locked down the Strait of Hormuz.
China in particular has relied heavily on the massive oil stockpiles it built up before the war, a move that now appears especially well timed. As oil prices rose, China dramatically reduced its crude imports by around 5 million barrels per day, according to JPMorgan.
It’s not entirely clear how much longer it can keep this up, but it probably has reserves large enough to go another three to four months, said Natasha Kaneva, head of commodities analysis at JPMorgan.
Meanwhile, countries coordinated by the International Energy Agency continue to release millions of barrels of oil each week from their strategic petroleum reserves — particularly the United States. That has helped cushion the blow from the biggest oil supply shock in history.
Emergency and commercial inventories are both now at or nearing operational stress levels, at which point physics no longer allows oil companies to easily pump oil out of storage into pipelines to get it to refineries. That spooked President Donald Trump in June, and he acknowledged that thinning stockpiles could result in “economic catastrophe.”
But in the three short weeks that the Strait of Hormuz had reopened, more than 200 million barrels of oil escaped the Persian Gulf, adding around 17 weeks of oil supply to the market and creating a temporary glut, according to Andy Lipow, president of Lipow Oil Associates.
That’s why, despite intensifying fighting that sent oil briefly above $100 a barrel last last week, many oil industry analysts kept their composure.
Daan Struyven, commodities analyst at Goldman Sachs, maintained his $80 forecast on Brent crude, the international benchmark, for the rest of the year. The risk, Struyven and others noted, is if the Strait of Hormuz remains closed to oil traffic for another extended period of time.
The market may be underestimating the risk of a prolonged oil standstill.
The Iranian toll problem
Despite the recent lull in fighting, Iran is still trying to enforce a high degree of control over the Strait of Hormuz.
Iran redirected vessels attempting to use what it described as an “illegal and unsafe route” through the waterway, state broadcaster IRIB reported on Monday, citing an unidentified “informed source.”
On Saturday, just one single ship transited the Strait of Hormuz, according to Windward Intelligence. Zero vessels entered.
Johannes Rauball, a senior crude analyst at Kpler, told CNN on Monday that vessel transits are currently “hovering near a complete standstill” through the strait.
Even during the 60-day ceasefire agreed on June 18, Iran required vessels wishing to transit the strait to coordinate with its newly established Persian Gulf Strait Authority or risk being fired on by its armed forces.
There is still huge uncertainty surrounding the trajectory of the war and whether Iran would reimpose hefty toll payments for ships transiting the strait as it did earlier in the conflict. Last week, an insurance trade group said policies could be torn up if ships pay Iran tolls to transit the strait, because that would violate US sanctions.
The conflict has also widened to encompass another critical maritime trade route, the Bab al-Mandeb Strait located at the base of the Red Sea. In recent days, Iran-backed Houthi rebels have attacked Saudi Arabian oil tankers and declared a blockade of the strait.
“The main market risk remains the energy and shipping front,” Deutsche Bank analysts wrote in a Monday note, adding that Houthi attacks raise “the prospect of simultaneous disruption to both Gulf and Red Sea export routes.”
“So (there’s a) welcome pause from the main actors but a fragile one, especially with side battles going on,” they wrote.
The market is optimistic over the likelihood of Strait of Hormuz reopening, yet “terrified” that it won’t happen for months, Lipow noted.
“We certainly have seen this movie before,” he said. “The market just violently reacts to the latest headline or, in this case, no headline.”
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