Oil Market Glut Narrative Recedes as Supply Chokepoints Tighten

Less than a month ago, analysts were warning of a looming glut of crude oil as tanker traffic through the Strait of Hormuz began to recover amid a U.S.-Iran ceasefire. Within days, the ceasefire had become a distant memory, missiles were flying again, and Yemen's Houthis were striking tankers in the Red Sea, leaving two blocked oil chokepoints and raising the risk of a global recession.

Brent crude topped $100 per barrel this week after reports that the Houthis struck two Saudi tankers in the Bab el-Mandeb Strait. Saudi Arabia is currently using that route as the main outlet for its crude amid the Iranian blockade of the Strait of Hormuz. Tankers headed for the Red Sea waterway soon began making U-turns and taking alternative routes, which are longer and more expensive. Those detours matter because even when cargoes are not physically lost, longer voyages tie up ships and raise freight costs, adding another layer of strain to an already disrupted market.

At the same time, Ukrainian drone strikes on the Caspian Pipeline System's terminus on the Black Sea have forced Kazakhstan to suspend most of its oil exports. The target of the drone attacks was the Novorossiysk port on Russia's Black Sea coast, which is also the departure point for most Kazakh oil exports to global markets. Bloomberg reported this week that tanker operators were becoming wary of sending vessels to Novorossiysk because Ukrainian drones were also striking ships at the port.

The Strait of Hormuz once handled an average of about 20 million barrels of oil per day. That flow has now slowed to a trickle. The Bab el-Mandeb chokepoint has been carrying between 4 million and 5 million barrels per day of Saudi oil in recent weeks, according to different estimates. Now it, too, appears to be almost completely blocked. Combined with the loss of 1.7 million barrels per day in Kazakh flows to Novorossiysk, the global oil supply picture looks increasingly grim. Ukrainian forces have also continued targeting Russian refineries, which has already triggered a temporary ban on diesel exports at a time when global fuel inventories are being strained by the first-wave effects of the Middle East war.

The situation in refined petroleum products is a crisis in its own right. "Unlike crude oil, refined products face far fewer mitigation options. Several Middle Eastern refineries remain affected by the ongoing conflict while Russia's diesel export restrictions continue to constrain global availability," Ole Hansen, Saxo Bank's head of commodity strategy, said in an analysis earlier this month. "Refining capacity globally also remains relatively limited, preventing crude supply increases from quickly translating into additional diesel and gasoline production," he added. That distinction is important for importers and refiners because tightness in diesel and gasoline can filter quickly into transport, industry, and agriculture even if headline crude balances look more manageable.

As a result, global refining margins reached an all-time high, underscoring how tight fuel markets remain despite the millions of barrels of crude that had managed to exit the Strait of Hormuz in recent weeks before peace negotiations between Tehran and Washington broke down.

The crises are already weighing on demand for crude and fuels. In Europe, where diesel stocks are tight, consumption fell 5.7% in May, according to International Energy Agency data cited by Reuters. In China, diesel consumption also declined in May by 10%, while gasoline demand fell by a more modest 5%. Meanwhile, global crude stocks are being drawn down.

"The large strategic stock releases earlier in the conflict have meaningfully depleted the buffer available for any future disruption," Vortexa analyst Mick Strautmann said earlier in July, according to the Wall Street Journal. The head of the International Energy Agency, however, said there was still ample oil in OECD storage for further releases if needed.

"IEA countries still hold a substantial volume of emergency stocks in reserve, including over 1 billion barrels of government-controlled stocks," Fatih Birol said in a statement on oil markets this week. He added, "There is no room for complacency on oil security amid the escalation in hostilities and a continued drawdown of available commercial inventories."

According to IEA data, global crude oil demand fell by close to 5% in the second quarter of the year, reflecting the oil price spike caused by the war in the Middle East. That is a clear sign of a tight physical market, even after media reports in June began warning of a glut on the horizon.

In that context, it is not surprising that the World Bank is again revising its global growth outlook. The institution's chief economist, Indermit Gill, told Reuters that the World Bank now expects the global economy to expand by only 1.3% this year, down from 2.9% last year. That may still prove optimistic if the wars disrupting energy supply chains continue. For now, that appears to be the most likely outcome, with little sign of peace. The risk of recession, in turn, is very real.

By Irina Slav for Oilprice.com