“Sleepwalking into Crisis”: Why The Oil Market Hasn’t Imploded Yet | Kpler’s Matt Smith

Matt Smith of Kpler describes the Strait of Hormuz as effectively closed for roughly four months as of the recording date in June, halting approximately 15 million barrels per day of crude and 5 million barrels per day of refined products. Of the 100 to 120 vessels that normally transited daily, only a handful move at any given time, mostly Iranian tankers or vessels carrying LPG or humanitarian cargo. The standard IMO-designated lanes are avoided due to mining risk, and ships that do pass go through Iranian waters, possibly paying a toll. Production shut in behind the blockade is estimated at over 13 million barrels per day, roughly four times the 3 million barrel per day Russian loss feared after the 2022 Ukraine invasion, yet WTI is trading around 90 dollars per barrel, well below the 110-plus levels many analysts predicted.

The market has not imploded for several reasons that Smith says are running out of runway. The closure coincided with a seasonally weak spring demand period, China pulled back from crude buying rather than competing for scarce barrels, and roughly 30 OECD countries released strategic petroleum reserves and product stocks. The market was oversupplied by approximately two and a half to three million barrels per day from March through May, but that surplus has flipped to a deficit from June through August, with large deficits now compounding on top of the underlying production losses. Smith believes market participants are pricing in a near-term resolution to the conflict and says that optimism is misplaced.

The primary mechanism absorbing the supply shock has been a collapse in refinery runs rather than a drawdown of crude inventories. Global refinery runs have been cut by approximately 9 million barrels per day, with roughly 2 million barrels per day covered by inventory draws. Because refineries are simply not consuming crude, crude inventories outside the US and Japan have not drawn down sharply, with approximately 84 percent of the global crude inventory drawdown occurring in just those two countries. China, importing roughly 11 million barrels per day before the closure, halted buying and dialed back refinery runs, making approximately 4.5 million barrels per day available to the broader market and reselling already-purchased West African barrels back into the market. Smith believes China may stay out for another month or two but will eventually have to return as onshore inventories draw down.

The product side carries the most acute stress. Europe was sourcing 45 to 50 percent of its jet fuel from the Middle East before the closure, and jet fuel inventories at the ARA hub have drawn down approximately 45 to 50 percent since the start of the year. US refiners shifted yields toward jet fuel, pushing US jet fuel inventories to their highest level of the year, but that shift reduced gasoline and distillate output. US distillate inventories are now at a 23-year low. Diesel is being pulled from the US to Australia and Africa because those regions can no longer source it from the Middle East Gulf. India and China have both restricted refined product exports as protectionist measures. Clean product exports globally fell from roughly 20 million barrels per day to 16 million barrels per day, a 20 percent decline visible in Kpler data.

Cushing crude inventories have been dropping roughly one million barrels per week over the last eight to nine weeks, falling from the low 30 million barrel range to close to 20 million barrels. Kpler drone surveillance over Cushing showed an additional 1.4 million barrel drawdown not yet reflected in EIA data. When Cushing reaches approximately 20 percent of capacity it hits operational minimums where no further draws are possible, which narrows WTI versus Brent and slows US crude exports. US crude exports hit a record 5.6 million barrels per day last month, up from 4 million barrels per day before the conflict, but Smith predicts exports will fall below 5 million barrels per day in June as available barrels dry up. He estimates US commercial inventories have a usable buffer of roughly 60 million barrels above their functional floor of 350 to 380 million barrels.

Smith points to approximately July as when the market could rupture based on current inventory trajectory, with US inventories having roughly one to one and a half months of runway remaining. He says the US is currently in the best position globally, meaning deterioration there signals severe conditions everywhere else. Even if the strait reopened immediately, a sequential process of clearing tankers, discharging in Asia, drawing down onshore stocks, restarting refineries, and ramping production would keep market conditions similar well into September, with prices dropping only around 10 dollars on reopening. Smith estimates a decent likelihood the strait remains closed through November, and a Kpler dry bulk analyst predicted early on that closure could extend beyond a year. He identifies three possible resolutions: prolonged stalemate, a US concession on nuclear issues he characterizes as a US loss, or US military escalation, with the two sides described as far apart. He also warns that if Iran weakens further and has less to lose, it may activate the Houthis to close Bab el-Mandeb, which would force tankers around the Cape of Good Hope and add approximately four weeks of transit time, cutting the second major choke point to Asia.