The post-Covid recovery, Europe adjusting to the loss of most of its Russian gas, and Donald Trump’s moderation of tariffs have led traders to believe that things will always work themselves out. Amid strong corporate profits in the US, it may seem as if the global economy can withstand any blow and that Trump will, of course, back down before a catastrophe. The pain of a scenario that oil analysts have feared for decades is approaching. It won’t be pretty. Get ready
By The Economist
Someone was smelling butane. Energy experts had long warned that the Iran war was causing the biggest oil supply disruption in history. The closure of the Strait of Hormuz had blocked 14 million barrels of oil a day. To destroy that much demand, they said, the price of Brent crude would have to be more than double its pre-war level, well above $150 a barrel. But oil traders were in a state of stupor. Even as recently as April 17, prices were below $90 a barrel. Over the past week, amid rumors of new fighting, they have begun to wake up. On April 30, prices jumped above $125.
Unfortunately, as bad as things are, the disconnect from reality persists. Not only may prices still have room to climb higher, but the oil futures market, where speculators bet on the direction of the price of oil, tells us that prices will fall every month for the rest of the year, closing 2026 around $88. That means most of this shock will soon be undone. If so, traders must believe that three things are true: that America and Iran will soon reach a peace deal; that their deal will reopen Hormuz; and that, once the strait is free, gasoline and jet fuel will once again be plentiful. All of this is uncertain.
One thing everyone should be able to agree on is that for the strait to remain closed would be a disaster. At the start of the war, much of the oil was in storage or in tankers at sea. But ships that had passed through Hormuz before the conflict had all docked by April 20. Oil stocks will soon be at their lowest level since satellite tracking began in 2018. Gasoline, diesel and jet fuel stocks are already so low that supply gaps will be inevitable. And in America, demand for gasoline is set to explode as summer tempts people to get in their cars and travel.
Everyone must also recognize what is at stake. Asia’s petrochemical industry has already taken some of its capacity out of service. Since the war, diesel and jet fuel prices have doubled in Asia and more than doubled in Europe. Unlike stock markets, where bubbles can only be kept alive by the animal instincts of investors, the price of oil is tied to the real economy, at gas pumps, ports, and airports. If supply falls short of demand, prices must rise to restore equilibrium. There are already reports of diesel barrels selling for $600. Artificial euphoria cannot replace reality.
The case for optimism is clear. Donald Trump’s wild tweets signal not only that he is directionless, but also that he will intervene whenever oil prices rise too high. Iran’s economy is in shambles: it needs money urgently, which means it will also demand a deal. If a stalemate brings ruin to both sides, it will be over. We don’t want to question those who have the facts in hand and billions of dollars at stake. However, markets have a poor track record of assessing geopolitical risk. And with oil, they have a hard time assessing the complexity of physical trade. Even if a deal is in the interests of both countries, it can be difficult to finalize. Each side can underestimate the other. Trump seems to think he holds all the cards. But Iran has previously faced long disruptions to oil exports, at the start of Trump’s own “maximum pressure” sanctions campaign in 2018.
Iran is not a democracy, and the regime can survive while its people suffer. It has an incentive to hold out, hoping for a better offer, for as long as it can. Donald Trump could resume bombing, but that is as likely to delay a deal as it is to accelerate it.
Likewise, with the midterm elections approaching in America, Iran’s leaders may think that Trump cannot tolerate a high oil price. However, Donald Trump is selfish. He could try to curb rising prices at home by restricting exports of refined products. The midterm elections are already lost, at least in the House of Representatives, he may think. He is probably less concerned about the careers of Republican politicians than about his own humiliation if he reaches a nuclear deal with Iran that looks worse than the one Barack Obama struck in 2015. His latest signal to Iran is that he is preparing for a long blockade.
Even if a deal is reached, the strait may not be fully reopened. The daunting details of a nuclear pact will take months to negotiate. Now that Iran has discovered it has leverage, it may be tempted to use threats to close the strait again. And threats could lead to attacks. Perhaps Trump will put the end to the nuclear program before fully reopening the strait; after all, America is an energy exporter. Assuming America would allow Iran to treat Hormuz as a tollgate, what then?
And even if the strait is open in principle, the actual loading of fuel into the tanks will remain affected by many unknown delays. A flood of oil can be expected, as tankers that have been waiting escape fully loaded to the Indian Ocean. But returning empty tankers to the Persian Gulf will be more complicated. Many of them will have reservations on other routes. The strait will need demining, which could take months. Insurance rates can be prohibitive, so governments may need to organize a scheme to cover extreme risks. The production shutdown may have damaged oil wells. Restoring production will also take time. Partially shut-down refineries will not immediately return to full capacity.
The world is just beginning to understand what is coming. Central banks could soon face the second inflationary shock of the decade, following the Covid-19 pandemic. In Asia, many governments have already taken drastic measures, such as shortening the working week. European governments will also have to change gears. So far, they have focused on supporting consumer demand. They may have to cope with the collapse in demand and, given the possibility of diesel and jet fuel shortages, plan to protect the supply of food and essential services.
It’s never going to happen, is it? Even optimistic investors could be in for a nasty shock. The post-Covid recovery, Europe’s adjustment to the loss of most of its Russian gas and Donald Trump’s moderation of tariffs have led traders to believe that things will always work themselves out. Amid strong corporate profits in the US, it may seem as if the global economy can withstand any blow and that Trump will, of course, back down before a catastrophe. The pain of a scenario that oil analysts have feared for decades is drawing near. It won’t be pretty. Get ready.