Wall Street analysts are scrambling to get a grip on the financial and economic implications of the latest Middle East war. Understandably, the biggest primary impact is going to be on energy prices, with almost everything else flowing from that.
Judging by the volume of “umm, we think this will be shortlived and stand by our forecasts” vibe, a lot of the sell-side has evidently been caught on the hop by recent developments.
At least JPMorgan’s oil analysts to their credit open their report by admitting they messed up: “Our base case assumed that an unprecedented disruption would remain improbable. That assumption failed.” Yup.
The price of a barrel of Brent crude has already jumped to 8 per cent to $78.50. The big US-listed oil ETFs aren’t yet open for trading, but WisdomTree’s London-listed $1.1bn CRUD, a UCITS eligible ETC is up 7 per cent on the day. How high could it go if things don’t return to normal? Alphaville has raided its big inbox of sell-side research to find out, and the answer is that nobody really knows.
After all, about a fifth of the world’s entire supply of oil flows through the Strait of Hormuz, which is now almost closed to traffic. Here’s a great graphic the FT dataviz wizards made over the weekend.
The International Energy Agency estimates that about 4.2mn barrels of the 20mn barrels of oil that usually pass through the chokepoint on average every day can be redirected to other pipelines and ports, but that’s still a lot of oil that is right now going nowhere. Moreover, a lot of the extra OPEC capacity that could be deployed to ameliorate supply pressures is itself inside the Strait.
There’s onshore storage capacity for about 343mn barrels of oil across the affected Gulf states and Iran, plus another 60 or so empty tankers loitering in the neighbourhood that could take another 50mn barrels, according to JPMorgan. But this still means that if the Strait stays shut, then the Gulf can only produce oil for another 25 days before being forced to shut down production, the bank’s analysts note.
They therefore reckon that oil prices could go as high as $120 a barrel if the conflict doesn’t calm down quickly:
If the conflict abates by Monday sundown, coinciding with the start of the Jewish holiday Purim, the oil price spike could prove shortlived.
The main risk in our view remains that the regime could lose command and control over the IRGC—as highlighted by the recent attack in Oman—which would introduce a far more unpredictable and destabilising scenario for regional oil supply and markets. Retaliation from Hizbollah could further amplify these risks.
A prolonged escalation—especially if Iran applies economic pressure—could push prices much higher. We estimate that if the conflict lasts more than three weeks, GCC oil producers would exhaust storage capacity and would be forced to shut in production. Under this scenario, Brent could trade in the $100-$120 range.
Barclays have a similar take, if with a slightly more moderate forecast. In a note published on Saturday night, Amarpreet Singh, the bank’s lead oil analyst, reckoned Brent could hit $100/bbl. And his commentary does seem alarming:
The potential effect on oil markets is hard to overstate. Above-ground inventories in days of demand are tighter than they were before Russia’s invasion of Ukraine. OPEC spare capacity is also tighter than it was back then. Net seaborne total oil exports out of Saudi, UAE, Kuwait and Iraq, producers that command virtually all the spare capacity, stood at almost 19 mb/d last week (4wma), 850 kb/d above the same period in 2022 (Figure 1). NON-OPEC+ supply growth is decelerating sharply. L48 onshore crude oil production grew just 100 kb/d Q4-to-Q4 last year (Figure 2) while demand remains strong.
At the same time, risks to the supply are unprecedented. . . . For perspective, a third of all seaborne oil exports globally transit that point. Including refined products, a fourth of all seaborne exports globally transit through it. Saudi Arabia could reroute 4-5 mb/d of exports using the East-West pipeline but the Red Sea route might not be fully immune to this conflict either.
Media reports suggest OPEC+ might announce a larger supply increase tomorrow in the wake of these attacks but that might not be of much help immediately, as the risk to supply is much greater.
Meanwhile, Goldman’s commodity team has decided to leave its base case crude price forecasts, which assume no sustained supply disruptions, unch. Wait what?
Their analysis doesn’t ignore the closure of the world’s global supply route. It just thinks it’s temporary — estimating a $18/bbl real-time risk-premium corresponding “approximately to our estimate of the fair value effect of a six-week full halt in Strait of Hormuz flows”.
And, to be fair, a squint at the oil futures curve suggests that this has been the market’s understanding so far — with the price of oil deliveries in the short-term jumping higher, but longer-term contract prices being almost entirely unbothered:
They point to no confirmed damage to oil production or to oil export infrastructure in the region. And their preferred point estimate for global spare capacity is 3.7mn b/d, though this is largely concentrated in Saudi Arabia and the UAE which would put it largely on the wrong side of any sustained closure of the Strait.
Moreover, they estimate that a halving of Iran’s crude exports down to 1mn b/d would add only $8 to the fair value of oil. Alphaville finds it tricky to see how 1mn b/d of crude can easily be shipped if the current wave of air strikes continues, but that’s really the point of Goldman’s view: they won’t be.
Anyway, here’s a handy quick guide, courtesy of GS analyst estimates, as to what a one-month closure of Hormuz does to the fair value of oil:
Jordan Rochester at Mizuho reckons that the global economy “won’t feel it” if crude dips back below $75 a barrel, and even if it stays at the current level, it will only lift inflation and soften consumption for a few months.
What happens if the Strait doesn’t reopen? Bad things:
During last year’s 12-day war, analyst estimates ranged from $80-130/b if Hormuz were closed. Every sustained $10/barrel rise knocks roughly 10-20bp off growth over the following year. Oil at $120 staying there would deal a serious blow to the US and global economy. And gasoline shocks can make or break political support — a factor that will be weighing heavily on the President’s mind.
If this is going to weigh on the President’s mind, we can imagine Xi Jinping will be hyper-focused given that China’s imports of crude come in at over 11mn barrels per day — almost twice the US total.
According to Erica Downs at the Center on Global Energy Policy at Columbia, China has built a reserve of 1.21bn barrels of oil in storage onshore. This would be enough to cover over 100 days of net crude oil imports at the 2025 level. Which is lucky, because Downs also reckons that the country has been importing around 1.4mn b/d from Iran, around an eighth of their total crude imports.
We can’t show you a chart of China’s Iranian imports because China says there are none. However, they do say they import 1.3mn b/d from Malaysia, almost three times the country’s entire production, and more than 10 times Malaysia’s declared oil exports to China. Moreover, tanker tracking suggests that a tonne of Iranian oil heads to Malaysian waters, where illicit ship-to-ship transfers have been notorious. Given the fungibility of oil, lack of Iranian supply will show up in more demand for other sources.
A barrel of oil in the wrong place isn’t worth anything in the short term. In fact it’s a liability. Having a gazillion barrels stuck behind an effective embargo caused by a combination of Iran/ Iranian proxies’ ability to disrupt their traffic and insurers unwilling to offer tankers cover means the rest of the world has to auction the remaining supply among itself. In a world of meaningfully constrained supply, the oil price will be bid to whatever level shuts down economic activity of the almost marginal buyer.
Working out who this unsuccessful marginal buyer is that gets priced out of existence, if only temporarily, is too hard for us.
