Partial Workarounds and Residual Shortfall

Our Global Commodities Strategist Martijn Rats discusses how the Strait of Hormuz shutdown has created a deep air pocket that will likely keep markets tighter and prices higher for longer than many expect.

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Welcome to Thoughts on the Market. I’m Martijn Rats, Morgan Stanley’s Global Commodities Strategist. Today – an update on the global impact on the Strait of Hormuz shutdown.

It’s Tuesday, March 24th, at 3pm in London.

More than three weeks into the Iran conflict and the Strait of Hormuz disruptions, the numbers are striking. Normally, around 35 oil tankers leave the Gulf each day. Today, that number is closer to zero to two. That amounts to a shock. In fact, we estimate this event has disrupted roughly 20 percent of global oil supply – double the scale of the Suez crisis in the 1950s. 

Now, you might think: can’t the system adapt? Can’t oil just flow another way? At first, oil kept moving by being stored on ships already inside the Gulf. But that buffer is now full. Floating storage has surged in the area to over 120 million barrels, and new loadings have effectively stopped. Once storage is filled, producers have no choice but to cut output – and that’s exactly what we’re seeing. About 10 million barrels per day of upstream oil and gas production is now offline. 

Now once we reach this point, the Hormuz closure becomes a real supply loss. There are some partial workarounds. Pipelines that bypass the Strait. Strategic reserve releases. Possibly, naval escorts at some point to help ships move along. But unfortunately, none of these fully solve the problem. Even after accounting for all these offsets, the market still faces a shortfall of around 10 to 12 million barrels per day. Now, that is more than three times the supply shock markets feared in 2022, when Brent oil prices surged to around $130 a barrel. 

And beyond crude oil, the supply strain is showing up even more in refined products. Now, how so? By comparison, crude oil is still flexible. One barrel can sometimes be substituted with another. But refined products – like jet fuel or petrochemical feedstocks – are much more specific. They’re harder to replace quickly. And we’re already seeing acute shortages. 

Europe relies on imports for about 37 percent of its jet fuel needs, and those flows have now declined sharply. Middle East exports of naphtha, a key input for plastics and chemicals to destinations in Asia, have fallen from about 1.2 million barrels per day to almost zero. And in shipping hubs like Singapore, marine fuel prices have surged dramatically, with some fuels exceeding $250 per barrel. Once fuel shortages hit logistics, the disruption spreads beyond energy to affect the movement of goods across the economy. 

So where does this leave us? We envision two broad scenarios. First, a reopening. Even if the Strait reopens relatively quickly, say within one to two weeks, the system doesn’t just snap back. There’s what we call an air pocket in the system – a gap created by delayed shipments, empty inventories, and disrupted supply chains. In that case, oil prices are still likely to stay elevated throughout the second and third quarters, rather than quickly returning to pre-crisis levels which were about $70 per barrel at the time. 

A second scenario would be a prolonged closure. If the disruption continues, the market shifts from substitution to rationing. And rationing means demand has to fall. Historically, that only happens at much higher prices – typically in the range of $130 to $150 per barrel. 

Now given all this, we’ve revised our base case forecasts higher. We now expect Brent oil prices to average around $110 per barrel in the second quarter, easing only slightly to $90 in the third and $80 by the fourth quarter. But it’s key to realize that reopening the Strait is not the same as repairing the system. This supply chain shock to the oil market will take time to unwind.

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