The Largest Oil Disruption, Ever…

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Due to Iran shutting the Strait of Hormuz and striking oil infrastructure, about 10 million barrels are currently offline. Unavailable. Bloomberg Economics has mapped out scenarios in which the Strait of Hormuz is closed for 1, 2, or 3 months. Their analysts say that oil could reach $165 if it stays closed for 3 months. That would be $100 higher than pre-war. We’re only 13 days into the war, and prices for Brent crude have topped $100.

I suspect Bloomberg’s analysis is optimistic. [Note from Adam: To get breaking commentary from Jim and all the other Paradigm editors, simply download our free app and go to the “daily feed” section. It’s available for both Apple and Android phones.Download the app here.] Some people may be wondering how “only” a 10% drop in supply (10 million barrels) can raise prices by more than 50%.

Demand for oil is “inelastic”, meaning it’s very firm. People still need to drive to work, ships must deliver goods, power plants continue running, and planes must fly. It takes a large increase in oil prices to get people to stop doing these things. So a small drop in supply can have a big effect on price. For example, in 1973, oil supply dropped by around 3 million barrels per day. The price of oil quadrupled from $3 to $12.

Today, it’s not just a 10% drop in production that is offline due to the chaos in the Gulf region. That is also where most of the spare capacity was. Specifically, most of it was in Saudi Arabia and the UAE. Countries which are now cut off from their shipping routes. Our friend Dan Amoss, Senior Analyst at Strategic Intelligence, shared a table by Rapidan Energy Group showing the percentage of supply disrupted in various conflicts.

They estimate that today’s situation has disrupted 20% of supply in total (including surplus capacity which could have come online before the war). According to Rapidan’s research, this is the largest oil supply disruption in modern history. Here’s an excerpt: Rapidan Energy Group’s proprietary historical disruption dataset – covering every major supply event since 1950 – confirms that Gulf War III has exceeded any prior disruption by more than 2x.

During the Suez Crisis – the last time a disruption approached this scale – spare capacity stood at ~35% of global supply and was located largely in the US, where it was available to global markets. That cushion no longer exists. So today there’s nearly zero spare capacity. While strategic reserve releases will ease the pain in the short-term, it’s simply not enough. And those limited reserves will only last about 130 days.

In the first days of this war, Jim Rickards told readers that, “The big winner will be Russia, which can make up for Persian Gulf shortfalls to some extent with its own exports.” Russian oil, much of which was previously sanctioned, will help address demand in the short run. President Trump has granted India a temporary pause on restrictions against importing Russian oil. So many of the Russian “shadow fleet” tankers will now find it easier to deliver their oil.

The financial media is catching on to the story. Here’s the Financial Times today: “Russia is earning as much as $150mn a day in extra budget revenues from its oil sales, making it the biggest winner from the conflict in the Middle East.” Normally, the country would be able to pump more oil on short notice. But Ukraine has a habit of targeting their oil tanks and refineries with drone strikes.

So sometimes they look like this: So due to the war with Ukraine, Russia’s ability to ramp up oil production is limited. Look, I don’t want to come off as a gloom & doomer here. But historically, there are nasty side effects when oil spikes. Sharp rises in the price of oil tend to cause slowdowns in the housing markets. Sometimes crashes. In the early days of this war, I didn’t expect it to last more than a month.

But now, both sides appear to be digging in. Trump is sending conflicting messages. At a rally in Kentucky yesterday, he stated, “We’ve won… in the first hour it was over.” But then he said, “We don’t want to leave early, do we? We got to finish the job.” Meanwhile Iran does not agree with Trump’s assessment. Their leaders are vowing to fight until the U.S. admits it was wrong and pays reparations (not going to happen, obviously).

While their navy and capital have been decimated, Iran continues to launch missiles and drones. Israel, Bahrain, and the UAE have all enacted strict censorship outlawing citizens from sharing war footage. The only potential off-ramp I see is if President Trump declares victory without achieving regime change. I think that would be a satisfactory outcome for most Americans. Hopefully we can reach a solution to this conflict in the very near future.

Because if the Strait of Hormuz stays closed, and oil infrastructure continues to burn, we could see $200/barrel oil. That would undoubtedly set off a global recession, stock market crash, and humanitarian crisis in much of the world.

Summary

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