The Biggest Oil Supply Shock in History Is Hitting — So Why Haven’t Prices Spiraled Out of Control?

Global oil prices broke through $100 per barrel this week, with crude futures returning to near two-month highs. However, judging from current price performance, amid continuously declining global oil inventories and energy supply pressures extending beyond the Iran conflict, the severity of this energy crisis may be underestimated.

Brent crude fell to around $96 per barrel on Friday (24th), but still rose approximately 10% for the week. September Brent crude futures closed at $100.69 per barrel on Thursday, the highest closing level since May 22, and significantly higher than earlier levels this year.

Although oil prices have returned above $100 per barrel, they remain far from the $138 level economists warned in March could trigger a global recession if sustained for three consecutive weeks. This also does not match the 'largest crude oil supply deficit in history by 2026' described by the Dallas Federal Reserve. According to estimates, the current supply gap is about twice the size of the 1973 oil crisis.

Natasha Kaneva, Head of Commodities Strategy at JPMorgan, pointed out that the current Brent price of around $100 per barrel is only $13 above the bank's estimated fair value of $87 for July, indicating that the 'geopolitical risk premium' currently reflected in the market is actually quite limited. The risk premium refers to the additional cost paid by the market to guard against future supply disruptions.

Analysts note that since the outbreak of the Iran conflict, approximately 11.1 million barrels per day of global crude supply have been affected. However, the use of strategic reserves by various countries, along with slowing demand from China, has allowed the market to temporarily absorb the supply shock. In 2022, during Russia's invasion of Ukraine, crude prices briefly surged to $147 per barrel.

However, it should be noted that global supply buffers by 2026 have been significantly weakened. According to Kpler data, global crude inventories have declined from slightly above 3.7 billion barrels in March to about 3.45 billion barrels in June.

Goldman Sachs analysts warn that if Persian Gulf supplies continue to be disrupted, oil prices could climb back to $120 per barrel. Baird notes that once global inventory buffers are depleted, $120 per barrel could become the price level that forces demand reduction and rebalances supply and demand.

Most commodity analysts did not anticipate that the Iran war would last this long, nor did they expect the Strait of Hormuz to become a bargaining chip. At the same time, China’s reduction in crude imports and use of hidden reserves to stabilize global oil prices has also exceeded market expectations.

Nonetheless, the oil market has so far managed to compensate for supply gaps through various means, avoiding more severe price spikes. Now, market focus has shifted to what might happen next.

Jeffrey Baird, Founder and Portfolio Manager at Merritt Point Partners, said: 'Overall, we believe we are currently in a crisis.'

He pointed out that the world still relies on massive inventories as a buffer, but time is running out. Potential disruptions to shipping through the Bab el-Mandeb Strait this week could further deplete limited supply buffers.

Moreover, the crude supply crisis is not solely due to the Iran war, now entering its sixth month. Baird stated that the largest-scale oil supply shock in history actually dates back to the Russia-Ukraine war in 2022, now exacerbated by threats to Saudi Arabia’s crude exports and shipping through the Bab el-Mandeb Strait.

He believes that, taken together, this represents the 'largest supply-side shock in oil market history.'

However, traders generally still believe that the Iran war cannot continue indefinitely, or it would trigger a catastrophic supply crisis. Therefore, the crude futures market currently still expects Brent crude prices to fall back to around $85 per barrel later this year.

Baird noted that the Trump administration is highly sensitive to rising oil prices, so whenever prices rise sharply, the market is more inclined to bet that the U.S. will de-escalate the conflict or even actively seek de-escalation.

Brent crude briefly fell below $60 per barrel at the beginning of this year, climbed to over $118 by the end of March, dipped toward $70 earlier this month, and has now rebounded near $100.

Ultimately, Wall Street’s oil price forecasts will eventually be proven right or wrong. But if the Iran conflict continues to disrupt global crude supplies into the fall, market focus will shift to U.S. gasoline prices and American voters’ perception of high fuel costs ahead of the November midterm elections.

Pavel Molchanov, Investment Strategy Analyst at Raymond James, said: 'The closer we get to the midterms, the more likely White House Iran policy will be influenced by political factors.' This means the market will continue to face more unpredictable news and sustained volatile crude prices.