Oil: Are you ready to hit the wall?

Source: here

About six weeks ago, Trump attacked Iran in a manner very similar to how Russian president Vladimir Putin attacked Ukraine in 2022. There was no obvious justification for the attack, which was blatantly illegal and has proven costly to everyone, including Trump himself.

In addition to sparking further tension between NATO partners and alienating US allies in the Middle East, Trump's attack on Iran triggered a spike in oil prices from around USD 65 per barrel to a peak (so far) of around USD 110 per barrel as markets priced in closure of the Strait of Hormuz. In normal times, about 20% of the world's supply of crude oil travels through Hormuz. Today, almost all of this oil is shut in. The rise in oil prices is already eroding the global economic outlook.

Source: here

Unfortunately, as IMF has just pointed out, the real oil shock may still lie ahead. By 'real oil shock', I mean the actual disruption to physical supply rather than mere market speculation by oil traders, which is all we have seen so far.

Hardly anyone has yet experienced an actual shortage of oil, but this may be about to change. It takes about 4-8 weeks for crude oil leaving Strait of Hormuz to reach its various destinations, so most regions are still being supplied, albeit not for much longer.

A few producers are also able to increase output, but not by much in the short term. Some countries hold crude oil in reserve, which buys them some time. It is estimated that total strategic reserves of crude currently stand at about 1.8 billion barrels. Given that the world consumes about 105 million barrels each day, the strategic reserves buy us about 17 days.

We are therefore looking at between 24 and 31 days until the world hits the wall as far as oil supply is concerned, meaning when each of us have to curb our actual consumption of oil by a fifth. This prospect prompted IMF Director Kristalina Georgieva to call on governments to economise on energy use in anticipation of the approaching shock.

Unfortunately, most governments - rich and poor alike - are doing exactly the opposite. Rather than curbing consumption, they are trying to offset the increase in oil prices by cutting fuel taxes.

However, cutting fuel taxes only makes the shock worse as they increase demand. Why, you may well ask, are our governments doing something so silly? The reason is as old as the hills; governments are myopic, so they are hoping that Trump and Iran will somehow reach an accommodation in the near future that obviates the need for demand curbs.

Let us hope they are right. But how likely is a quick resolution? As I see it, the prospects are rather unclear. On one hand, Trump is evidently afraid of high oil prices, because he reins in his attack dogs every time prices go up. On the other hand, Trump does not appear willing to make concessions to Iran as he fears his deal will look inferior to Obama's JCPOA. In fact, the issues of real substance do not appear feature in talks yet.

Trump's oil dilemma (Source: here)

As long as we are stuck on the horns of this dilemma, the most likely outcome is a back-and-forth scenario, which will no doubt be accompanied by copious amounts of insider trading by members of the Trump Administration.

Time may ultimately prove to be the decisive factor. Time favours Iran for two obvious reasons. First, with every day that passes without a resolution the world draws closer to hitting the supply wall, which is likely to prove extremely painful for everyone, including American voters. Second, every day that passes without a deal brings Trump closer to his Waterloo at the mid-term election in November.

Of course, given that Trump is in charge one cannot rule out truly crazy scenarios about which I am in no position to speculate other than to say crazy scenarios tend to have very bad outcomes.

The End