Over the past three months, oil markets have witnessed something extraordinary. The largest supply shock in history has — this time — failed to trigger a deep energy crisis. With only slight exaggeration, one could say that oil shocks are no longer what they used to be. Following the US-Iran agreement, it is now increasingly likely that conditions in the oil market will begin to normalise relatively quickly.
How fast could that return be? Given the unprecedented scale of the supply disruption, views differ considerably. We are, however, cautiously optimistic. If the Strait of Hormuz is safely navigable and shipping is no longer burdened by extraordinary costs, oil from temporarily shut-in fields could return to the market fairly quickly — within a matter of weeks. Pre-war production capacity could be restored within several months. Even that, however, may not be necessary to close the market deficit, as production outside OPEC has increased in the meantime, while oil demand has weakened.
Another positive factor is that, unlike in previous Middle Eastern conflicts, oil infrastructure has suffered only limited damage this time. The risk of long-lasting production losses therefore appears contained.
Still, the process of normalisation will be constrained by at least two factors. First, a risk premium is likely to remain embedded in prices over the coming months, reflecting persistent uncertainty about the precise terms of the agreement and its implementation. Over the longer term, Iran’s coercive leverage will likely remain a wild card: Tehran has demonstrated that it can bring the Strait of Hormuz under control relatively quickly.
Second, restoring stability to the oil market will require a rebuilding of inventories, which have been drawn down at a record pace over the past three months. In the world’s largest economies, inventories are now close to their lowest levels since at least 2003. Until commercial and strategic reserves are replenished, the oil market will remain vulnerable to renewed supply shocks.
At the same time, it is important to stress that the underlying fundamentals of the oil market have not changed materially. The long-run oil price remains relatively firmly anchored around USD 65 per barrel, broadly in line with the marginal cost of production for US shale producers. Moreover, the conflict in the Middle East has further weakened the OPEC cartel, following the departure of the UAE, which has a clear ambition to supply significantly more oil to global markets. If the supply side of the market fully normalises — including inventory levels — a return of oil prices to the USD 60–70 per barrel range is a realistic assumption.
This is also a crucial point from the perspective of the broader European economy. If an agreement is concluded swiftly and the Strait of Hormuz is reopened, the current energy shock would likely prove to have been temporary, limiting the further spilling-over effect on both inflation and economic growth. In that case, the recent rate increase by the ECB may be regarded as a measured and appropriate response to heightened uncertainty, while future policy decisions would remain guided by incoming data rather than signaling the start of a tightening cycle.
SOURCE LINK : Oil Shocks Are Not What They Used to Be. Prices May Have Further to Fall
