Iran war is a smokescreen for a looming oil market crunch as Chinese demand wanes

Despite the predictions of shortages, crude prices are resisting a breakout beyond $100 per barrel

IN OVER 25 years as a financial journalist I have learnt the hard way never to bet against human ingenuity.

Each time a crisis struck, the consensus view claimed that this time was different. The system might never recover. Yet, every time markets eventually found a way to adapt. That does not mean the crises were not real. They were. But the system does not stay stagnant. People change behaviour. Businesses find alternatives. Engineers solve bottlenecks. Politicians adjust incentives. Traders discover new routes. Capital flows to wherever it is needed most.

The current oil market appears to be telling us the same story once again.

For months, commentators have warned that geopolitical tensions, disrupted trade routes and shrinking emergency stockpiles would inevitably culminate in a severe energy shock.

Yet despite the constant predictions of looming shortages, oil prices are stubbornly resisting a sustained breakout beyond $100 per barrel.

Why? Part of the answer may lie in things markets can sense that journalists and policymakers cannot easily observe. For example, Donald Trump revealed on Wednesday that American military efforts have been more successful at facilitating the movement of previously stranded oil cargoes than many appreciated.

Such developments are difficult for journalists to verify in real time and may not immediately appear in shipping data. Yet physical flows have a way of revealing realities through prices in ways that headlines miss.

Even accounting for Trump’s most generous estimates about how much oil has been released, this is not enough to explain the gap between the dire forecasts and the comparatively restrained behaviour of oil prices. Something bigger is happening. The first possibility is linked to emergency stockpiles.

When many think of so-called “strategic reserves”, they picture a giant warehouses whose sole purpose is to release oil when supply disappears. That view increasingly misunderstands their function. The US Strategic Petroleum Reserve was conceived during a period when bringing new production online could take years.

But the shale revolution has changed that reality. Today, the United States possesses an enormous reserve that does not sit in storage caverns but beneath the ground itself.

At the right price, production can respond incredibly quickly. And this is exactly what has been happening. Weekly US oil exports have soared to a record high of 5.35 million barrels.

The modern function of emergency reserves is therefore less about replacing lost supply indefinitely and more about buying time while the system reorganises itself.

The panic over these stockpiles being tapped out in the weeks and months to come may therefore be misplaced. The second underappreciated factor is the extraordinary flexibility of modern refining, arguably one of the most sophisticated industrial systems ever created. When shortages emerge, refiners do not sit passively waiting for salvation. They alter yields, change feedstocks, adjust maintenance schedules and redirect product flows.

Three months ago many feared acute shortages across a range of oil products. Today the situation remains tight, but thanks to the ingenuity of refining engineers, the widespread disruptions have largely failed to materialise.

Global oil demand entering into the crisis looks to have been weaker than anyone realised. Long before the crisis began, signs were emerging that China’s ability to absorb ever-growing quantities of crude oil was approaching its limits. Floating storage around the world was swelling. Inventories were building. Import growth was slowing.

At the time, few paid much attention. The dominant assumption remained that China would continue acting as the world’s buyer of last resort, absorbing excess supply whenever needed and providing a floor beneath global commodity prices. That assumption now looks increasingly questionable. The market may have fundamentally underestimated the elasticity of Chinese oil demand. Importantly, elasticity is not the same thing as demand destruction. Rather than consuming less to achieve a balance, it means reorganising, substituting or optimising operations while preserving much of the same economic output. Indeed, had traders known in November last year that Chinese crude imports would collapse by the magnitude currently being observed, it is not supply shortages that they would be worrying about.

A much greater concern would have been the fiscal and economic fallout of oil heading well below the break-even rates of most Opec members.

Many of these need at least $80-90 per barrel to sustain current spending commitments. Viewed through that lens, the Iran crisis may be acting as a smokescreen for a much greater adjustment in the global economy. One that the US, with a break even rate of around $50 to $60 per barrel, was always poised to benefit from. If that is correct, the most important barrels in the oil market are not the ones being disrupted by conflict.

They are the ones China is no longer buying because markets are finally being allowed to do their thing.