The closing of the Strait of Hormuz has been described as one of the largest oil supply shocks in history, yet many are puzzled by the relatively restrained oil prices. Economists weigh in on why prices haven't surged even higher.
Massive Supply Disruption
The United States-Israel conflict with Iran stranded approximately 20 million barrels per day of oil and related products due to the closure of the Strait of Hormuz. Oil prices initially spiked but have since stabilized around US$100 per barrel, according to a note from Bank of Montreal senior economist Art Woo on May 15.
Reasons for Contained Prices
Woo estimates that three-quarters of the stranded barrels are crude oil, with the remainder being products like diesel and jet fuel. Saudi Arabia and the United Arab Emirates have increased pipeline flows by about six million barrels per day, mitigating some of the shortfall. Additionally, supplies are being drawn from sovereign petroleum reserves, and countries such as Canada, Norway, and Venezuela have ramped up production.
Elevated prices have also led to demand destruction, particularly in Asian and African nations dependent on Middle Eastern energy. These countries face power outages and reduced working hours as they curtail consumption.
National Bank of Canada economist Jocelyn Paquet adds other factors: the global economy now uses less oil per unit of GDP, and before the conflict, oil production exceeded consumption by about four million barrels per day. The duration of the shock also matters; the Iran conflict is still in its early stages compared to the five-month Arab oil embargo of the 1970s.
Uncertain Outlook
Both Woo and Paquet warn of uncertainty ahead. Paquet notes that further production increases are unlikely, as even U.S. shale producers would need three to six months to bring additional supply to market. Without a resolution to the nearly three-month-old conflict, the world will continue to rely on strategic petroleum reserves and commercial reserves. The U.S. reserves are on track to fall to their lowest levels since 1982 if the expected drawdown occurs.
