Key takeaways:
- Our base case remains a messy resolution, with tail risks still lurking. Our core conviction is that the deal should be read simply as a Memorandum of Understanding (MoU), not as a binding treaty or permanent resolution.
- Structural factors remain a risk to the deal, with tensions likely to continue over control of the Strait of Hormuz, alongside US-Israel tensions over certain aspects of the MoU.
- We continue to expect oil to eventually settle with a geopolitical risk premium in the US$80-90/bbl range, rather than fully mean-reverting. The role of China, and the extent to which it normalises imports, remains a key question.
- How the current phase of the conflict is resolved is unclear, and with global inventories being drawn down, spike risk will remain the longer it continues.
The last few days have seen a re-escalation of tensions between the US and Iran, consistent with our base case of a “messy resolution”: a structurally unstable MoU with key issues still unresolved.
In recent days, Iranian hardliners have pushed for clear control of Hormuz, carrying out a number of strikes. The US has responded with strikes in Iran and an escalation to a reinstated blockade. Meanwhile, US threats to charge a 20 per cent toll on traffic through Hormuz, while seemingly untenable, point to continued contestation of sea lanes. These developments are consistent with our expectation that oil is likely to carry a risk premium as it absorbs these shocks, likely remaining in the US$80-90/bbl range through the rest of the year.
The key concern is that recent tit-for-tat strikes have expanded beyond previous post-MoU episodes, with traffic in the Strait of Hormuz nearing a complete halt and spike risks coming sharply into focus.
Current vessel-tracking data suggest flows through the strait are deteriorating again after recovering to around 80 per cent of normal levels several weeks ago. Throughput is now approaching pre-MoU lows, implying more than 10mbpd of supply disruption. If sustained, this would significantly increase the probability of oil prices retesting US$100/bbl or higher.
To date, China has helped cushion the shock through inventory drawdowns and softer demand, but this buffer is finite.
A prolonged disruption would steadily erode available inventories and leave global oil markets increasingly exposed to further supply losses. This clearly highlights the additional tail risks, and the fact that these risks rise the longer the disruption continues. While the focus has largely been on China’s crude oil imports, China has also signalled caution by regulating and rationing demand across the broader supply chain. On policy, China has temporarily and selectively relaxed exports of refined petroleum products for July. However, it has also introduced a temporary export ban on helium, a strategic input for semiconductor production, signalling that China is securing supplies and preparing for a potentially longer and wider disruption.
Separately, even before the latest escalation, gas prices had started to creep higher despite the earlier fall in oil prices, with the increase intensifying in recent days.
This likely reflects three factors. First, European gas storage remains well below historical norms ahead of the winter refill season, meaning European market activity is likely to increase. Second, Chinese liquefied natural gas (LNG) imports have risen, reducing the previous buffering effect. Third, the normalisation of LNG flows out of Hormuz has been slow. This highlights another potential tail risk in a commodity where price responses have so far been more contained.
Rising commodity prices are also beginning to push inflation breakevens higher again, adding to pressure on bond yields that were already elevated due to rising real rates, particularly in the US.
This likely complicates the task for central banks, which had been taking some relief from easing inflation pressures and associated second-round effects. While policymakers can look through short-lived supply shocks, a more persistent disruption risks a more hawkish policy path ahead.
