Global oil markets are moving through a fragile phase in which geopolitical risk, maritime disruption, depleted inventory buffers, and stress across refining systems are converging. The immediate US-Iran war risk premium has unwound sharply after the US halted its attack on Iran over the weekend and Iran avoided striking US military bases in the region. That pause helped global crude oil prices correct by 15 percent, with Brent trading under $85 on Tuesday after reaching $100 last week. For a third consecutive day, the US and Iran held back from further attacks, while Tehran signalled it would refrain from retaliation as negotiations with Oman continued over the Strait of Hormuz.

Yet the market’s relief appears premature. Physical flows remain constrained, and the risk of renewed escalation has not been removed. Global crude oil supplies are tightening as flows through the Strait of Hormuz remain impaired. The International Maritime Organization has recently warned that it is too dangerous to cross the Strait of Hormuz at the moment, while visible transits through the waterway have fallen sharply as Iran continues targeting tankers attempting to move through it. For a market that still depends heavily on Gulf exports, even a partial disruption is enough to tighten balances and lift volatility.

Hormuz Cannot Be Bypassed Quickly
The assumption that Gulf producers can rapidly reroute exports away from Hormuz is only partly valid. Saudi Arabia’s East-West pipeline and UAE export routes together appear capable of redirecting roughly 8-9 million barrels a day of crude and product exports outside the strait, which can materially reduce the imbalance during the crisis. Planned UAE expansion alone could raise bypass capacity from 1.5 million barrels a day to 3 million barrels a day by 2027. However, even under a broader adaptation scenario across the Gulf, we estimate roughly 7-9 million barrels a day of Gulf crude and product exports could still depend on the strait.

That remaining exposure is the central issue for the market. We continue to believe crude markets are understating the effective supply gap created by the war and the disruption around Hormuz. The risk remains skewed to the upside as Iran gradually tightens its control over the strait and the broader Gulf security environment. In a market where spare logistical capacity is limited, even a short interruption to physical flows can create an outsized price response.

The second major supply impulse is coming from the Russia-Ukraine war. Ukraine’s intensified drone attacks on Russian oil infrastructure have disrupted major refineries, reduced crude processing, and forced tighter controls on fuel exports. Russian crude production fell to 8.3 million bpd in June, its lowest level in 2.5 years, while repeated attacks have kept roughly 2.5 million bpd as it currently processing 3.5mbpd of refined products from a capacity of 6.72 mbpd, lowest in 24 years. The shortage is reflected in crack spread in US and higher product prices in Europe.

India’s position in this system also deserves attention. India ranks fourth globally, with crude processing of roughly 5 million bpd, making it highly exposed to price spikes, freight dislocation, and shifts in Russian crude and product flows. Any combination of tighter Gulf flows reduced Russian refinery output, and stronger war-risk premiums could complicate refinery margins and import planning for major Asian buyers.

Inventory Buffers Are Eroding
Another reason oil prices have not reacted more violently to a full-fledged war in the Middle East is that OECD countries have been drawing down strategic petroleum reserves. Roughly 700 million barrels of reserve inventories were used from March to June. That leaves very little margin for a prolonged war. If further physical supply shocks emerge, the market will have fewer buffers available and would likely price crude higher with greater speed.

Oil price risks therefore remain skewed to the upside. Renewed threats to the Bab el-Mandeb Strait and attacks on Kazakhstan’s Caspian Pipeline Consortium export route are adding to supply risks just as the market’s remaining buffers continue to erode. US tariffs have briefly shifted investor attention toward weaker demand, but tighter physical balances leave Brent increasingly vulnerable to renewed price spikes. Shipping data reinforce that caution: crude oil stored on tankers stationary for at least 7 days rose +3.5% w/w to 102.84 million bbl in the week ended July 24.

Outlook
Near-term oil prices are likely to remain extremely volatile. The diplomatic channel between the US and Iran, mediated by Oman, remains fragile, and the probability of renewed hostility in the region is still material. Prices could also react sharply to any headline suggesting that Washington and Tehran are moving toward peace, although we remain doubtful after the latest escalation, even after the signing of the MoU on June 17th.

Brent crude could retreat to an average of $80 a barrel by 4Q, well under current prices near $85, if elevated prices ultimately force de-escalation. However, renewed hostilities continue to support BI’s $90-$110 frozen-conflict scenario in the near term. The 4Q outlook therefore rests on a narrow balance: high prices may incentivise diplomacy, but continued disruption around Hormuz keeps the risk profile firmly tilted to the upside.

Source: Business Standard