The Mother of All Oil Shocks

The Strait of Hormuz standoff has created an oil market crisis far greater than the one caused by the 1970s oil embargoes. This is not “Europe’s problem,” as some U.S. government officials suggest, or China’s problem, or something purely temporary. Nor can the damaging impact be lessened by record U.S. petroleum exports—besides, how does that help you at the pump?

If we include oil, liquefied natural gas, sulfur, and other products, the equivalent of some 30 million barrels of oil is typically produced in the Persian Gulf region and exported daily. The volume today has been reduced by nearly 90%, with the rest flowing through Saudi, Emirati, and Turkish pipelines. This is monumental.

It’s important to understand that tankers move at a snail’s pace. Many of the oil and petroleum products that have reached their destinations since late February started their journey before the war began. Even if the stalemate could be resolved tomorrow and oil shipments quickly resumed, it will take weeks, perhaps months, for needed products to arrive.

More importantly, consider what’s happened to the world’s oil reserves. Most of the 8 billion or so barrels held in the world’s commercial stockpiles are what is known as “working inventories”—that is, oil and petroleum products that do not sit in storage waiting for an emergency, but actually feed global commercial supply chains.

JPMorgan estimates that current commercial stockpiles provide a cushion equivalent to just 2.3 days in excess of normal worldwide consumption. Will those stockpiles be rebuilt when the conflict is resolved? Probably not, because production has stopped growing—and will likely soon decline, given the depletion of major U.S. shale deposits. Though the oil market was supposedly 2 million barrels in surplus last year, slowing production explains why stockpiles didn’t grow.

Now look at government-managed strategic reserves. Some 2.5 billion barrels make up the world’s total government-controlled stockpiles, of which China owns 55%—and China will do with them what it wants, not what the United States tells it to do.

By contrast, the U.S. controls just 15% to 17%. Since Feb. 28, when President Donald Trump and Israeli Prime Minister Benjamin Netanyahu started the war in Iran, U.S. production has not increased, but exports have soared to some 13.6 million barrels per day.

The U.S. has managed that by selling oil from its strategic reserve. Since the start of the war, some 70 million barrels of oil have been released into the market from U.S. government stockpiles. Given that neither the U.S. nor the rest of the world is increasing production, how will the U.S. rebuild its inventory?

What all this points to is a supply shock the likes of which we have not seen before. The artificial manipulation of prices by the use of the strategic reserve will cease sooner rather than later, and the impact on the global oil market, including the U.S., will be of a different order than what we’re already seeing.

Some of these forces were at work before the war, in particular, the lack of production growth. But the disruption caused by the conflict has magnified them to an extent that will only become fully apparent in the near future—even if an end to the conflict can be negotiated soon.

It is obvious that these considerations were absent from the folks who decided that all it would take to bring down the Iranian regime would be to blow up Ayatollah Ali Khamenei on Feb. 28.