Oil above $100 a barrel has been the number unsettling markets ever since the war in Iran disrupted shipments through the Strait of Hormuz in April, as fears grew that a prolonged shortage would send prices higher, lift inflation and squeeze growth took hold.
That pressure slightly eased yesterday morning, when Brent slipped back below $100 towards the bottom of its range over the past month, but the relief was temporary, as this morning the price surpassed that threshold again.
In good news, it never reached the $150 a barrel that some of the most bearish forecasts had pencilled in, as Felipe Villarroel, manager of the Twentyfour Dynamic Bond fund, noted. But the feeling of ‘doomsday averted’ might be temporary.
“There was some demand destruction, obviously, as oil prices went up, but we also have big importers such as China and Japan reducing their imports,” he said.
Meanwhile, exports are being diverted: the UAE is using a port that bypasses the Strait of Hormuz, while Saudi Arabia has aims of doing the same through the Red Sea.
“The Strait itself hasn't been entirely closed through this period and other producers have increased their exports in this period too,” he said.
But those workarounds have a shelf life, he said. A temporary ceasefire that let some oil through Hormuz and held prices at $80 to $90 would be enough for the economy to live with and would not need the conflict to end.
“At some stage, China has to rebuild its inventories. At some stage, the US cannot continue increasing its exports; it will reach capacity. And so, this is just a reminder that we do need to have some sort of medium-term equilibrium, even if it's an unstable one, because otherwise we are at risk of oil prices continuing going higher. But for now, this doomsday scenario is definitely being averted.”
Johanna Kyrklund, chief investment officer at Schroders, agreed.
“The supply buffers in energy markets, namely floating storage [oil held on tankers at sea] and strategic reserves have largely been exhausted,” she said.
“We must therefore remain alert to the possibility of persistently high energy prices, which in turn complicate the outlook for central banks.”
While she normally would have encouraged everyone to ignore the headlines and focus on medium-term trends, this time it's different, and on Trustnet she suggested to “keep an eye on oil, gasoline, diesel, jet fuel and gas prices”.
While most investors watch how much crude passes through the Strait, Adam Rozencwajg, co-founder and portfolio manager at Goehring & Rozencwajg, thinks the real shortage is further down the chain, in refined fuels like diesel, gasoline and jet fuel.
The Hormuz closure in April took about 10 million barrels a day of crude production out of the market and his firm expected stocks to run dry within 100 days. That did not happen and the usual explanation is that demand fell by about 6 million barrels a day to close the gap.
Rozencwajg rejected that, giving airline and vehicle miles at record highs as an example. A demand loss that size would normally come with a major recession, yet there isn’t one.
If demand had really dropped, there would be no shortage of fuel and fuel prices would simply follow oil down.
“Instead, what we saw back in June and July is oil prices fall and diesel, gasoline and jet prices stayed at all-time highs,” he said. “So now the spread between crude oil and refined products is at a record price.”
The loss was therefore in refining capacity – about 6 million barrels a day of refining capacity was lost in China, the Middle East and Russia. Part of the reason is that refined fuel has barely left the Gulf during the crisis. Shipping it out is far riskier than shipping crude, he said.
“If a missile hits a crude tanker, the crude spills into the water. If a missile hits a gasoline product tanker, it explodes, so it's just too dangerous.”
That shortage is the most ignored metric because it is hard to see in the data. Reported demand is usually based on what refineries process, as that is far easier to count than fuel burned by cars every day. Normally this approximation works, but when refineries themselves are the bottleneck, lower refinement capacity can get reported as weak consumption.
“That's the one piece of data where, unfortunately, we have no visibility into it whatsoever. Satellite images can't capture it, nothing can capture it,” he said.
Stocks of diesel and jet fuel could therefore be falling without anyone having a reliable count. Rozencwajg expects crude to fall when the war ends and then rally as buyers rush to refill those stocks.
To position for this, in his funds, he shifted out of gold and into oil and US natural gas in January and February, as he recently told Trustnet.