The Strait of Hormuz remains closed, with the flimsiest of ceasefires looking flimsier by the hour. Oil prices have jumped back above $100 a barrel. At times like these, it’s important to remember that things can still get much, much, much worse.
The main reason why the impact of the Strait of Hormuz’s closure hasn’t been even more grievous is a record-breaking drawdown in strategic oil reserves in the US, Europe and Asia, myriad privately owned commercial inventories around the world, and the steady arrival of tankers that had escaped the chokepoint before the conflict erupted.
Together, these have acted as a powerful shock absorber for the global energy market, keeping the price increases a little bit contained. As Barclays’ Ajay Rajadhyaksha wrote this week, it’s like the world has lost its job but has kept living reasonably comfortably off its crude oil nest egg and unemployment benefits.
Unfortunately this nest egg will now soon be spent, and the government cheques are set to run out, unless the Strait reopens pronto. And while stock markets have proven surprisingly resilient so far — largely thanks to a bumper quarter for corporate earnings — some analysts are sounding increasingly worried.
Natasha Kaneva, head of commodities strategy at JPMorgan is one of them. She thinks that the “illusion of plenty” could shatter soon, with “operational stress levels” looming and potential “broader system instability” by the autumn if the Strait remains closed.
While the world began the year with the equivalent of over 8bn barrels of oil in tankers, pipelines, depots, and salt caverns, in practice . . .
. . . Not every barrel can be drawn. Out of the 8.4 billion barrels in global inventories, we estimate only 0.8 billion barrels are realistically available without pushing the system into operational stress. As of April 23rd, roughly 280 million barrels have already been consumed to cushion the impact of the conflict. On paper, that still suggests comfortable buffers. In practice, the picture is more complicated. Floating storage can be tapped quickly, but only a slice of onshore inventories — around 580 million barrels — is readily accessible. The rest is effectively locked up in pipeline fills, minimum tank levels, and other operational constraints.
This is why inventory floors matter. A market can still hold hundreds of millions of barrels, and yet become fragile once working stocks fall too low. Like blood pressure in the human body, the issue is circulation. Pipelines lose pressure flexibility, terminals cannot load efficiently, refiners struggle to secure the right grades on time, and traders bid aggressively for nearby supply. The system does not fail because oil disappears, it fails because the circulation network no longer has enough working volume.
The same principle applies to refined products. Product inventories are somewhat more flexible than crude, but a meaningful portion must still be maintained as a strategic and operational buffer — particularly to support critical sectors such as transportation and aviation.
OECD inventories offer a clear example of this operational floor. Historically, OECD product inventories, including both commercial and strategic reserves, have rarely fallen below ~35 days of forward demand, roughly 1.6 billion barrels, suggesting a practical lower bound.
In a prolonged disruption scenario, demand is therefore rationed well before inventories approach critically low levels. In theory, stocks could last much longer — but only at the cost of reduced consumption, lower refinery runs, and a broader economic slowdown. As a result, a full drawdown of global inventories is neither feasible nor likely.
So how quickly will this begin to truly bite?
Kaneva argues that oil inventory drawdowns are a bit like an onion, with layers peeled off according “speed of access, economic cost, political willingness, and logistical ease” rather than simply who has the most oil.
The first layer to be unpeeled are tanker cargoes and storage vessels, which are easy to redirect where they’re needed. Then comes other commercial inventories — refinery tanks, oil terminal depots and storage facilities in places like Cushing. After that we begin to peel off government oil reserves, like the US Strategic Petroleum Reserve in Louisiana and Texas.
Kaneva says we are now at the fourth layer, where higher prices begin to de facto ration oil for consumers — “demand destruction”, as it’s often called.
Consumers drive less, industry cuts runs, airlines trim schedules, and refiners reduce throughput. In effect, the market is shifting from a “managed” adjustment — driven by SPR releases and floating storage — to a “forced” adjustment, where price becomes the primary balancing tool. Observed global oil demand fell by an average of 2.8 mbd in March and is tracking a larger 4.3 mbd decline so far in April. Demand losses are expected to deepen to around 5.5 mbd in May, as demand destruction must scale to prevent the system from hitting operational floors. Given the magnitude of the demand pullback, our balance now suggests OECD commercial inventories are on track to approach operational stress levels by early June.
The fifth layer? Well, there be dragons . . .
Operational minimum stocks are typically the last barrels drawn, and, in practice, are deliberately avoided. Pipeline fill, tank bottoms, linepack equivalents, minimum terminal inventories, and the product stocks required for day-to-day continuity are rarely accessed, because drawing them materially increases the risk of operational disruption and broader system instability. On our estimates, OECD commercial stocks could fall to these operational floors by September if the Strait of Hormuz remains closed, assuming demand destruction stabilizes at 5.5 mbd.
Kaneva and her team have been fairly downbeat for some time. But even Rajadhyaksha — who has been notably more optimistic than most other analysts since the conflict erupted — is now suddenly sounding glum.
Barclays estimates that global inventories are now dwindling at a rate of as much as 80mn barrels a week, and could hit a “precarious” level as early as later this month if nothing else changes. And that is ominous for other markets, Rajadhyaksha warns.
The next few weeks are the runway that the world economy has left, before demand destruction really kicks in.
. . . after one of the strongest April months on record for equities, we worry that markets have decided that the energy shock simply doesn’t matter anymore. If so, we disagree — this is a crisis delayed, but not yet averted. It is time, we think, to turn cautious on risk assets.
. . . The buffers worked. They were designed for exactly this. But they were designed for a disruption, not a new normal. And every week that passes without a resolution moves us a bit closer to the point where the insurance runs out.
JPMorgan’s analysts warn that there is therefore a growing risk of a “non-linear spike in oil prices”, with the cost of a barrel of Brent soaring to $150. Yay.
Further reading:
— Goldman reckons that oil could take out the 2008 record of $147 (FTAV)
www.ft.com
#growing #risk #nonlinear #spike #oil #prices
