[FREE] From Glutted to Gutted

Are We Approaching an Unprecedented Energy Crisis? Attempts to reroute or offset Iranian-throttled oil continue to fall short.

Happy weekend, Commodity Context subscribers!

As I have previously mentioned, we have joined a rotating roster of energy sector specialists who will be contributing to the weekly Dispatch Energy newsletter, which is entirely free to read thanks to a sponsor so you should subscribe!

The goal will be to share some of the themes we regularly write about here at Commodity Context but at a higher level and for a broader audience. We will also be sharing those write-ups here for our regular subscribers. The main story from our fifth contribution, Are We Approaching an Unprecedented Energy Crisis?, is reprinted in full below. You can also listen to the story via the recorded voiceover.

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Illustration by Noah Hickey/The Dispatch (Photos via Getty Images).

Welcome to Dispatch Energy! The Strait of Hormuz is the world’s most important energy chokepoint. This much has been well known and oft-mentioned for decades. Roughly 20 million barrels of oil—in addition to massive shares of other critical commodities, from liquefied natural gas to fertilizer—transit the narrow waterway daily. Or, rather, I should say, transited. Iran has effectively blocked the Strait of Hormuz—allowing very limited traffic in and out—since the U.S. and Israel jointly initiated the Iran war on February 28.

Let me be clear: If the Strait of Hormuz remains closed, there is no doubt that the global price of crude oil will explode to all-time highs. For context, I am not typically an alarmist about high-price forecasts. My first contribution to Dispatch Energy explored how the oil market was increasingly oversupplied, pushing prices lower. I was what many more price-optimistic oil market investors derisively referred to as a “glutter.” But the tables have very much turned. The continuation of the Iran war—and its possible escalation, through further attacks on oil facilities or boots on the ground—will, no doubt, force oil prices higher to (and potentially past) the peak of $147 per barrel in 2008 (about $223 in today’s money).

If the strait remains closed, the global oil industry will have no hope of filling that supply hole this year or next (or next). Even the fastest-responding sources of production, namely U.S. shale, simply cannot respond quickly enough or with anywhere near the required volumes. As inventories rapidly drain, prices will rocket higher to quell demand in a desperate effort to balance the equation. Destroying 20 million barrels of petroleum product demand per day is roughly equivalent to the peak of COVID-driven demand loss from March to April 2020, when roads were deserted and there were barely any planes in the sky. This time, the market will need to curb this magnitude of demand without mandated lockdowns.

So, let’s paint the theoretical picture of what destroying 20 million daily barrels of petroleum product demand would look like. In wealthy, advanced economies, there is almost no price too high. For example, I’m driving my kids to school in the morning regardless of the price at the pump. So, for me and most citizens of the global West and high-income Asia, this crisis will manifest as excruciatingly high prices that sap our disposable income—effectively a tax. All of the normal, energy price shock-related recessionary concerns will surface. But not everyone is so privileged. Poorer countries in the Global South won’t be able to afford those prices and, thus, won’t be able to incentivize the fuel cargo imports necessary to balance typical domestic demand. Put simply, these countries will experience the crisis as acute physical fuel shortages like the one Cuba is currently facing.

We should expect a disastrous lifestyle adjustment for people in those developing countries. The world will get smaller, power will be in shorter supply, and the tens—if not hundreds—of millions of people dependent on liquefied petroleum gas for cooking fuel will be forced to shift to dirtier biomass alternatives. We saw a now-infamous example of this shift during the energy price crisis, after the Russian invasion of Ukraine spurred a sudden and insatiable pull of global liquefied natural gas cargoes toward Europe in an effort to fill the massive gap left by the loss of Russian gas imports. As a result, some commodity traders broke term contracts for scheduled LNG deliveries to Pakistan to reroute to Europe, with the price difference more than covering any breakage fees.

And while there have been claims that the U.S., for instance, will be spared the effects of this energy price spike thanks to its newfound status as a net petroleum exporter, it’s important to remember that, when it comes to energy security of supply, a barrel of oil lost anywhere is a barrel of oil lost everywhere.

Just another supply crisis?

We’ve seen energy supply disruptions before, and commodities analysts are, admittedly, prone to sensationalism. So there may be temptation to draw parallels to the energy price shock of 2022 and, even, to call “boy who cried wolf.” But, while market panic was ultimately overstated in 2022, there is no doubt that the “wolf” is now here. There are two important differences between 2022 and 2026: The panic in 2022 was inflated by a pandemic-induced supply deficit, and the threatened 2022 supply crisis was relatively small.

First, a large part of the panic in 2022 was the preexisting, pandemic-induced supply deficit. The pandemic economic bullwhip effect had roiled energy supply chains since at least the latter half of 2021, as it had other industrial supply chains. Petroleum product demand was rebounding faster than expected thanks to the rapid vaccine rollout, while supplies floundered after being aggressively throttled by the combination of collapsing oil prices and the largest-ever production cut by OPEC+, a group of nations that controls crude output equivalent to around 40 percent of global petroleum output. Even more, U.S. production from the shale patch was recovering more slowly than expected due to the aforementioned supply chain bottlenecks, which caused shortages of everything from labor to steel pipes to frac sand. OPEC members, too, were struggling to lift output following rapid shut-ins and underinvestment.

In contrast, the world was actually oversupplied with oil heading into the Iran war. As outlined in October, global oil production was growing faster than demand heading into 2026. There was a widespread expectation that oil markets would be notably oversupplied to the tune of 2 to 3 million barrels per day and prices would, therefore, be under heavy downward pressure. But a surplus of 2 to 3 million barrels per day pales in comparison to the 20 million barrels per day of lost Hormuz flow.

Second, the threatened 2022 supply crisis never fully materialized. After Russia’s full-scale invasion of Ukraine in February provoked fierce backlash from Western countries, the International Energy Agency (IEA) warned in its April 2022 Oil Market Report that Russian oil production could fall by 3 million barrels per day—an unthinkable volume at that time. But Russian production didn’t fall by that volume. Instead, it dipped modestly for a month or two before recovering the prewar levels. On top of that, any oil market tightness was doused with water thanks to China’s draconian COVID-zero policies, which drove the first annual average decline in Chinese petroleum product demand in decades.

In contrast, the flow of disrupted oil through the Strait of Hormuz is seven times the feared loss and 20 times the realized loss of Russian supplies in 2022. While OPEC+ was forced to cut production in 2022 and continued cutting to stabilize prices through the end of 2023, a recession is the best-case scenario if the strait remains closed through 2026. The energy price spikes and forced demand shedding will be, very likely, depressionary.

Offset opportunities.

Fortunately, energy exports through Hormuz haven’t been entirely halted. Iran largely continues to deliver its oil to global markets through the strait unimpeded, which shaves 5 to 10 percent off the total loss. There is also the potential to shift some flows from the strait to pipelines around Hormuz. The largest pipeline option is Saudi Arabia’s East-West pipeline to the Red Sea, which could offset one-quarter of Hormuz’s normal flow. Built during the Iran-Iraq War in the 1980s with this exact contingency in mind, this pipeline could be used to reroute as many as 5 million barrels of oil per day (7 MMbpd total, 5 MMbpd pre-war unused space), according to Saudi Aramco, the Kingdom’s national oil company.

However, the pipeline alternatives have yet to live up to their touted potential. So far, we’ve only seen about half that volume rerouted through the East-West pipeline. Meanwhile, the risk of an Iranian strike on the conduit or the supporting infrastructure is ever-present, as is the threat of resumed attacks on global shipping in the Red Sea by the Iran-backed Houthis in Yemen. The United Arab Emirates has a pipeline that can move roughly half a million daily barrels to the Gulf of Oman (1.7 MMbpd total, 0.5 MMbpd pre-war unused space), but the termination point—the key blending port hub of Fujairah—has suffered repeated Iranian bombardment. Another set of pipelines could move more barrels from northern Iraq to the Turkish coast, but we haven’t seen much progress on that option based on tanker tracking data.

There is also temporary, policy-driven relief that can be provided to the market. Most significantly, we are seeing the largest ever IEA-coordinated release of strategic oil reserves, which, at 400 million barrels, is more than twice the 182 million-barrel record set in 2022. The U.S. Department of Energy has indicated that its own release contribution of 172 million barrels from the Strategic Petroleum Reserve would occur over 120 days. Globally, the release of 400 million barrels (which includes the US contribution) over the same time period means roughly 3.3 million barrels of daily outflow or replacement “supply.” In addition to the coordinated release, the U.S. Treasury has moved to temporarily waive sanctions on both Russian and, yes, Iranian oil. Tighter sanctions had made it difficult for both Russia and Iran to market their barrels, which left them stranded on tankers at sea. Both countries hold an excess of tens of millions of barrels that they’re likely to draw down now that those sanctions have been waived, contributing some additional effective oil supply for the first month of the Hormuz stoppage.

If all potential rerouting offsets are maximized—which they haven’t been yet—the Hormuz supply loss of 20 million daily barrels drops to around 13 million daily barrels. And the full brunt of that shortage can be further counteracted by waiving sanctions on excess Russian and Iranian oil on water and via the largest IEA strategic reserve release in history. But even accounting for these alternate supply routes, the global oil market is still left with a gargantuan supply deficit that will begin rapidly drawing down onshore commercial inventories. There is simply no other option: Traffic through the Strait of Hormuz must resume to stave off a cataclysmic economic shock.

Looking ahead.

With U.S. benchmark West Texas Intermediate (WTI) futures still below $100 per barrel, the closure of the strait hardly feels like a global crude oil emergency today. Oil prices are certainly higher than a month ago but far from all-time highs—and there’s been a flatlining over the past week or two. Clearly, financial markets continue to bet that President Donald Trump will pursue a quick end to the Iran war. But their optimism has proven unfounded thus far, and the stubbornly low price of oil is reducing any price-driven pressure on the White House to negotiate or back down.

And, for now, the U.S. appears to be the most movable participant in the Iran war. Israel will continue to pursue its goal of destroying the Iranian regime, and the Islamic Republic has remained recalcitrant on negotiations toward a ceasefire, demanding the recognition of its sovereignty over the Strait of Hormuz. Meanwhile, financial markets and energy prices in the U.S. will pressure the White House to try to avert the economic consequences I outline above. These considerations likely explain the shift in American war aims from regime change to the prioritization of reopening Hormuz.

Other countries have already begun to feel significant price pressures as a result of the war. The global benchmark for crude oil, Brent, is trading at more than $10 per barrel more than WTI—well above its usual premium. Barrels for immediate physical delivery in the Middle East are trading at more than $160 a piece. And jet fuel in Singapore has already spiked to more than $200 per barrel. What’s more, importers haven’t felt the real brunt of the lost supply yet. The loss of exports out of the strait is, effectively, an “air pocket” in the normal flow of barrels out of the Middle East, because tankers take roughly three to four weeks to transit to their destinations, namely Asia. Some of the tankers that departed the Gulf a month ago are still en route to their final destinations, but there’s nothing but air behind them. In other words, the “crunch” is coming and prices are on a precipice.

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