In a somewhat puzzling market development, oil prices haven't spiked yet to record highs amid the worst supply disruption in history.
That's because the market still hopes for a quick resolution to the Strait of Hormuz crisis (for more than three months now), global inventories have offered a supply buffer, the world's top crude importer, China, is staying away from spot purchases, and last but not least, demand destruction is accelerating amid the high prices.
Beyond the near-term supply chaos and conflicting signals about the Middle East war, analysts are wondering how much of the current demand destruction will be permanently lost once the conflict is resolved.
Inventories Ease The Shock from Lost Supply, So Far
The oversupply with which the market faced the beginning of the Iran war has helped to ease the upward pressure on oil prices as the conflict enters its fourth month. But global stocks, except in China, are being depleted at a record pace, suggesting that the buffer is stretching thin and the true magnitude of the supply loss will hit the market very soon.
Excluding China, which has accumulated large buffer stocks of more than 1.2 billion barrels over the past year, the rest of the world has seen onshore stocks draw at an accelerating pace, according to Kpler.
Global stocks drew down at a pace of just over 1.5 million bpd in early May. This drawdown rate has now jumped to nearly 1.7 million bpd, Kpler's data showed, suggesting that further tightness could lie ahead.
As inventories started to fall and prices spiked to $100 per barrel and beyond, consumers reduced demand. Asian consumers have been forced to slash consumption amid soaring fuel prices and government measures to curb fuel use, including shorter work weeks and work-from-home schemes for civil servants. But consumers in Europe and the U.S. are also curbing demand amid high fuel prices and air fares.
In America, the cumulative increased costs for gasoline since the U.S. attacked Iran on March 1 for consumers is now $40 billion, with $400-$600 million that Americans are paying more for gasoline every day over the past three months, according to Patrick De Haan, Head of Petroleum Analysis at GasBuddy.
Moreover, the U.S. Strategic Petroleum Reserve (SPR) is less than 10 days away from falling to its lowest level since August 1983, a level not seen since the SPR's initial fill-up that began in 1977, De Haan said on Monday.
Demand Destruction Kicks In
As costs soar, consumers rethink spending on gasoline. As inventories crash, oil prices tend to spike.
But demand destruction has been so high so far that it has capped price spikes, alongside China's reluctance to tap the spot crude market for purchases as it has amassed inventories that would last it a few more months.
In China specifically, demand has slumped by 9%, or about 1.5 million barrels per day (bpd), "abruptly, unexpectedly, and with remarkably little visible disruption," JPMorgan oil strategists Natasha Kaneva, Lyuba Savinova, and Artem Fakhretdinov wrote in a note carried by Yahoo Finance.
"It looks like consumers have made a quiet economic choice," JPMorgan's analysts said, noting that Chinese consumers have shifted to electrified transportation.
Consumers outside China are also making the economic choice of spending less on much more expensive fuels. Electric vehicle sales are soaring in Asia and Europe. American consumers, while not rushing into EVs with zero federal incentives, are rethinking driving and are commuting more as the highest gasoline prices in four years are changing consumer behavior.
The biggest question for analysts and for the oil market in the medium to long term is: will demand return after this crisis settles? Or will governments and policymakers choose to permanently replace some oil and gas consumption with low-carbon alternatives such as EVs and solar and wind power to avoid being caught off-guard during the next geopolitical crisis that will cripple oil and gas supply?
"Put differently, could the world actually function with something like 9% less oil?," JPMorgan analysts asked in their recent note.
For now, the world doesn't seem to have much choice. With the Strait of Hormuz still closed, inventories are being drawn down to critically low levels, and people are seeking to replace road transportation fuels with EVs or simply drive and fly less.
The longer the Hormuz crisis lasts, the more severe the current supply disruption will be, prompting permanent, conscious efforts by governments to avoid ever again being so dependent on the Middle East's oil and gas.
Some of the demand destruction that started as a knee-jerk reaction to the crisis could become a permanent loss of consumption.
Separately, demand destruction is currently helping keep a lid on oil prices.
Demand destruction resulting from higher prices will somewhat soften the blow from physically tighter oil markets, Goldman Sachs commodity analysts said in a note earlier this week.
But the inventory buffer is nearly gone, even China started drawing down its stocks, and with an inevitable Chinese rebound in crude purchases in the coming months, oil prices are set to surge this summer, when actual shortages may start to appear.
By Tsvetana Paraskova for Oilprice.com
