Crude oil futures are pricing market adaptability, not hopeful Iran peace: Russell

One of the debates since the start of the Iran war has been whether crude oil futures are accurately reflecting the stresses in physical markets for both oil and refined products, or if they are blindly optimistic that peace is around the corner. The Iran war between the United States and Iran continues along its volatile and unpredictable path, with renewed hope that a fresh pause in the mutual strikes is possible. That flicker of optimism was enough to lead global benchmark Brent futures LCOc1 lower in early Asian trade on Monday, with a drop of nearly 5% to around $92.06. But the Strait of Hormuz remains at best contested, and shipping volumes through the narrow waterway have collapsed after surging during a brief three-week ceasefire in mid-June between the Trump administration and Tehran. After the collapse of that deal and renewed U.S. strikes on Iran, Tehran responded by targeting U.S. bases in the Middle East and vessels trying to cross the Strait of Hormuz. Tehran also appears to have successfully activated its Houthi allies in Yemen to target Saudi tankers trying to transit the Bab el-Mandeb Strait. This cuts off a route for Saudi oil to reach refineries in Asia via the Red Sea port of Yanbu. The alternative is a far more lengthy and complex route through the Suez Canal, which also involves partially discharging cargoes and using the SUMED pipeline because of draft restrictions in the canal. Overall, the picture for physical crude is that exports from the Middle East remain constrained, with limited volumes through both the Hormuz and the Bab el-Mandeb straits. Additionally a lasting peace deal appears distant, with the United States and Iran far apart on key points and deeply mistrustful of one another. This situation would appear to warrant a far stronger response than has actually occurred in oil futures markets. Brent dropped as low as $70.14 a barrel on July 2 during the brief ceasefire and rallied 45% to a high of $102.00 on July 23, before easing back. That may look like an impressive rally, but the high reached is well below the peak Brent reached of $139.13 a barrel in the weeks after Russia invaded Ukraine in February 2022, an event that raised fears of the disruption of exports from Russia, which at the time was the second-biggest crude shipper. Those fears weren't really justified as crude markets adapted rapidly, rerouting Russian oil to buyers in China and India while Europe increased imports from the Americas and Africa. The situation with the Iran conflict is different insofar as there is a real disruption to crude supplies, and the longer it persists the more the buffers of inventory drawdowns and China's cutting of imports become strained. Hence the argument that crude futures haven't risen enough to reflect the risks of a prolonged disruption to Middle East crude supplies, a situation that appears increasingly likely. But rather than not pricing the worst-case scenario, or even pricing the best-case scenario of lasting peace, it's more likely that crude futures are pricing adaptability. The market is effectively betting that it can handle the disruptions by re-routing flows and ramping up alternative sources of supply. It is obviously more costly and time-consuming for Saudi Arabia's Red Sea crude from Yanbu to get to Asia through the Suez Canal, but it is possible and will be done if that is what the market requires. Similarly, other smaller workarounds are emerging, such as Iraq trucking fuel oil to Turkey, which when combined help alleviate the loss of around 10 million barrels per day (bpd) of crude and products from the Middle East. In effect, it may be the case that the market is betting that crude and refined product traders will be able to mitigate the worst of the Iran crisis.

Crude oil futures are pricing market adaptability, not hopeful Iran peace: Russell

Crude futures and the Iran conflict

Why markets may be pricing adaptability instead of peace

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