Why oil prices are stabilizing

Just a few days ago, the United States and Iran were once again engaged in military action over Iran’s effort to exert control over the Strait of Hormuz energy transit chokepoint. Yet oil prices continue to trade near their prewar levels, around $70 a barrel.

Are oil markets too complacent about the global supply of oil?

No. Oil markets are not ignoring the political realities of the Middle East or the risks surrounding the Strait of Hormuz. Instead, traders are not reacting to every headline from sensational media outlets. Instead, they are focused on the fundamentals of oil supply and demand. The market believes the probability of a prolonged supply disruption has declined and that the global economy remains well supplied with oil.

Every tit for tat missile strike between the U.S. and Iran matters only if traders believe a significant volume of oil will be permanently removed from the global market. As dramatic as the headlines may be, oil traders are increasingly convinced that the likelihood of a sustained supply disruption is low. Most importantly, it is clear that the U.S. will not allow the rogue Iranian regime to control the Strait of Hormuz. If Iran were to exercise sovereignty over the strait, it would, in effect, hold a missile pointed at the world economy. America may be more than self-sufficient in oil, but U.S. economic growth is strongest when the global economy is expanding. President Donald Trump and the people want a strong economy. Consequently, Iranian control of the Strait of Hormuz will not be tolerated.

Second, the market believes oil producers have greater flexibility than during previous Middle East crises. The U.S. is both self-sufficient in oil and a major exporter. Saudi Arabia maintains substantial spare production capacity, and other producers can increase output if prices rise enough to justify it. Markets understand that short-term disruptions in shipments through the strait do not necessarily create a global oil shortage.

Third, inventories matter. China and many other oil-importing countries entered the conflict with healthy commercial inventories. That cushion reduces the urgency to bid oil prices dramatically higher. Financial markets have also learned that geopolitical shocks often produce only temporary price spikes. History is filled with conflicts that initially sent crude prices soaring before markets quickly reversed those gains as actual physical disruptions proved far smaller than feared. Traders remember those episodes. They are reluctant to push prices sharply higher unless key infrastructure is destroyed or exports are interrupted for an extended period.

Markets are also looking beyond the conflict itself. Soft demand growth in several major economies continues to offset geopolitical risk. China’s household consumption remains weak, limiting growth in the country’s oil demand. At the same time, improvements in fuel efficiency and the growing adoption of electric vehicles have slowed long-term growth in global oil consumption. Even if supply tightens modestly, investors believe softer demand can absorb part of the shock.

SUPREME COURT WORRIED THAT COUNTING LATE MAIL BALLOTS COULD UNDERMINE CONCEPT OF ‘ELECTION DAY’

Finally, oil traders recognize that governments have powerful incentives to prevent an energy crisis. Strategic petroleum reserves remain available, while Saudi Arabia, the United Arab Emirates, and other Gulf producers are investing aggressively in pipelines and other alternatives to shipping oil through the Strait of Hormuz.

The oil market is not ignoring the danger posed by Iran. Rather, it is making a calculated judgment that, despite the fluid military situation, the physical flow of oil is far more resilient than the headlines suggest. As long as that assessment proves correct, crude oil prices are likely to remain far calmer than the conflict itself.

James Rogan is a former U.S. diplomat who later worked in law and finance for over 30 years. He writes a daily note on markets, economics, politics, and social issues. He can be reached at roganjames8202@gmail.com.