Oil market braces for shortages as reserves dwindle, conflict drags on

Global oil markets are facing renewed uncertainty as the conflict in the Middle East shows little sign of resolution, with Iran and Israel exchanging missile strikes and allied groups threatening to escalate. 

Prices surged at the start of the week but quickly retreated, underscoring both the volatility of the situation and the market’s fragile balance.

Sharp losses in prices on Tuesday followed the announcement of a halt in attacks by both Iran and Israel. 

Commodity analyst Carsten Fritsch of Commerzbank AG warned in a research note that “things are going to get worse” if the war continues to disrupt supply routes and inventories. 

He cautioned that hopes for a swift agreement to end the conflict and reopen the Strait of Hormuz have suffered a severe setback.

Escalation and fragile diplomacy

Even as oil prices eased after their early-week spike, the outlook remains tense.

Houthi rebels allied with Iran have threatened to impose a blockade on Israeli ships in the Red Sea, raising questions about whether Saudi shipments from Yanbu could also be affected. 

In the past, Houthis have attacked tankers passing through the Bab al-Mandab Strait, a critical chokepoint at the southern tip of the Red Sea.

Iran is also insisting that Lebanon’s future be part of any peace deal, complicating US efforts to broker an agreement. 

US President Donald Trump has expressed confidence that Israel will agree to a deal, but Israeli actions taken without US coordination have cast doubt on that optimism. 

Fritsch noted that while all parties have an interest in ending the war, “the path to lasting peace and the resumption of oil shipments through the Strait of Hormuz may be more difficult than Trump and many market participants currently seem to believe.”

Prices remain below spring highs

Monday’s price increase merely offset Friday’s decline, leaving Brent crude below $100 a barrel, well under the highs seen in March and April. 

Many traders still expect the conflict to be resolved soon, which would be in the interest of all sides.

But another factor is that the oil market has begun adjusting to Gulf supply disruptions through alternative channels.

Oil prices spiked 5% on Monday, but dropped more than 3% on Tuesday.

At the time of writing, the price of West Texas Intermediate was 3.1% down at $88.49 a barrel, while Brent crude was at $91.79 a barrel, down 2.6%. 

Rerouting supplies and US exports

Meanwhile, Saudi Arabia has ramped up use of its East-West Pipeline to Yanbu, which can handle 7 million barrels per day, though the port’s export capacity limits flows to 5 million. 

The United Arab Emirates has also increased shipments via its pipeline to Fujairah on the Gulf of Oman, capable of 1.8 million barrels per day.

Together, these routes have rerouted about 4 million barrels per day since the Strait of Hormuz was closed.

The United States has stepped in with record exports. Data from Kpler shows US seaborne crude exports hit 5.6 million barrels per day in May, with weekly shipments peaking at 6.3 million. 

More than 2.5 million barrels per day went to Japan and nearly the same volume to Europe.

Much of this surge came not from new production but from drawing down commercial and strategic reserves.

Since late March, US crude inventories have fallen by 86 million barrels, including 58 million from the Strategic Petroleum Reserve.

Asian demand weakens

At the same time, demand in Asia has softened. Kpler estimates refinery demand in the region is 2.7 million barrels per day lower than in March, driven largely by China. 

Customs data shows Chinese imports fell to an eight-and-a-half-year low of 7.8 million barrels per day in May, down 4 million from March. 

Independent refiners have cut processing volumes as margins shrank, exacerbated by restrictions on product exports since April.

Saudi shipments from Yanbu fell nearly 10% in May, largely due to weaker Chinese demand.

Riyadh raised official selling prices for Asia in May, then cut them in June and July, signaling a slowdown in consumption.

Inventory risks ahead

The remainder of the supply shortfall is being covered by inventory drawdowns, particularly in the United States.

But this strategy is reaching its limits. 

US crude stocks are now 3.5% below the five-year average, gasoline inventories are 5% lower than usual, and middle distillate stocks are at their lowest in 23 years.

Fritsch warned that “it is therefore questionable whether the US can continue to export this much oil without risking local shortages in the summer or, at the latest, in the fall.” 

He added that any resulting price increases would be politically inconvenient ahead of November’s midterm elections and could force Washington to impose export restrictions.

Outlook

The oil market has shown resilience by rerouting supplies and tapping reserves, but the underlying risks are mounting. 

With inventories thinning, Asian demand weakening, and Middle East diplomacy faltering, traders face a summer of heightened volatility.

Brent remains below $100 for now, but analysts caution that prices could spike if disruptions intensify or if US exports are curtailed.

As Fritsch concluded, the market should not be complacent. 

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