Brent slips as Hormuz traffic recovers to 35% of pre-war levels

Oil prices fell Friday as Commonwealth Bank of Australia estimated crude flows through the Strait of Hormuz have recovered to roughly 30%-35% of pre-war levels, draining the geopolitical premium that pushed Brent above $100 for the first time since May.

"At around $100, Brent is trading just $13 above our estimated fair value for July of $87 per barrel, implying that today's market appears to be pricing in only a modest geopolitical premium," said Natasha Kaneva, Head of Global Commodities Strategy at J.P. Morgan.

J.P. Morgan analysts said commercial traffic through the Strait is running at 50 percent of pre-war levels, or 11.1 million barrels per day, including nearly 7.0 million barrels per day of pipeline re-routing. Global oil demand fell by roughly 5.1 million barrels per day, offsetting nearly 46 percent of the supply loss, while China alone cut crude imports by about five million barrels per day.

The path of prices now hinges on how long disruptions persist. J.P. Morgan projects Brent will average around $94 per month if the conflict is contained to one month, but each additional month of disruption adds roughly $7-8 per barrel, lifting monthly averages to about $114 if disruptions extend to three months.

The recovery in Hormuz traffic marks a turning point after a conflict that propelled Brent up nearly 40 percent in July, putting it on pace for its strongest monthly gain since March. Brent closed at $100.69 per barrel on July 23, the first time it settled at or above $100 since May. The last time Brent traded above that threshold was before the conflict disrupted flows through the vital waterway that carries roughly one-fifth of global oil consumption.

Standard Chartered Bank's Energy Research Head Emily Ashford said price moves will remain "headline-driven, taking direction from near-term escalation and de-escalation in the U.S.-Iran conflict." The bank maintained its third-quarter Brent average forecast of $85 per barrel "on the expectation of sustained geopolitical risk, ongoing supply disruption, and dwindling strategic reserves." Ashford also flagged that the fragility of the memorandum of understanding and ceasefire, along with renewed attacks on vessels, has paused the normalization process.

The demand adjustment that capped prices

The demand-side adjustment has been extraordinary. J.P. Morgan analysts said the bulk of the demand loss was driven by physical shortages rather than higher prices, calling it "a forced correction, not the traditional form of demand destruction." OECD countries accounted for around 18 percent of the global demand loss, with the burden falling disproportionately on non-OECD countries and China.

China's ability to sustain crude imports roughly four million barrels per day below normal for another three months provides an ongoing buffer for the global market, according to J.P. Morgan. But the analysts warned that eroding global inventory buffers are finite. The world would need to release an additional 210 million barrels if the conflict lasts one month, 315 million barrels if it lasts two months, and nearly 500 million barrels if it extends to three months, on top of the 500 million already drawn down since the conflict began.

The U.S., which shouldered most of the inventory releases in April and May, is unlikely to repeat that performance, J.P. Morgan said, leaving Europe, Japan, and South Korea to replace the fading U.S. inventory impulse or allow demand to crater. Pipeline re-routing flows are becoming increasingly vulnerable to severe disruptions following reports that the Houthis have begun enforcing a Red Sea blockade, the analysts noted.

If flows through Hormuz and the Red Sea fall by another four million barrels per day from current levels, the market could still avoid an acute shortage, but only if demand stays close to today's depressed levels. China cuts both ways, J.P. Morgan noted: the same import restraint that helped cap prices becomes a tailwind once it reverses, with even a one million barrel per day recovery in imports from September adding about $3 to the fair value.

This article is for informational purposes only and does not constitute investment advice.