Can the oil market survive a forever war with Iran?

By David Goldman, Matt Egan, CNN

(CNN) — The Iran war has lasted far longer than many expected — and so has a functioning oil market.

Despite uncomfortably high fuel prices that have cost the average US household nearly $800 since the war started, crude is mostly getting where it needs to go more than six months into the war. That’s because the market has proven remarkably resilient, by circumventing the Strait of Hormuz with alternative transit routes, leaning on significant crude stockpiles and slashing global oil usage.

There are real questions about whether — and how long — those conditions can hold.

Some oil analysts say the oil market can maintain this new status quo for the foreseeable future, even if the Strait of Hormuz remains neither fully open nor shut. In that scenario, the Trump administration could, in theory, continue its standoff with Iran for an extended period of time.

But others fear the shoestring and bubblegum used to hold the oil market together will eventually fail, depleting global inventories to a “tipping point” level. Energy prices would have nowhere to go but up, perhaps forcing the United States to end the war to prevent economic disaster.

What’s preventing oil from surging?

The oil market has weathered the largest-ever supply shock better than many imagined was possible. Oil prices are elevated, but they haven’t reached their all-time highs.

That’s for three reasons, according to a research report published last week by Natasha Kaneva, chief commodities analyst at JPMorgan.

First, the market has managed significant workarounds to bypass or get through the Strait of Hormuz. Saudi Arabia has used pipelines to divert several million barrels of oil a day to ports outside of Iran’s reach, although the recent rapid-fire advances by Iran’s Houthi allies cast doubt on the viability of this Plan B. The US military has coordinated an effort with Gulf states to escort an undercover shuttle operation to get oil through the strait. The United States, Venezuela, Brazil, Guyana and Canada have ramped up their production by roughly 2 million barrels per day, combined.

“Barrels find a way to flow,” said Kaneva.

Second, most countries outside of the United States and China have drawn down their oil inventories far less than anticipated, preserving a stockpile of oil that governments can put to use if the situation grows significantly more dire.

And third, global demand for oil has fallen sharply during the war — by about 5 million barrels per day. Around the world (though not so much in the US), many consumers canceled travel plans, switched to electric cars or started taking the bus. Some businesses encouraged employees to work from home. China is exporting so many electric vehicles that it’s straining global shipping capacity. And a shortage of refining capacity in the Middle East, Russia and China has eroded demand, keeping a lid on crude prices.

Combined, those factors helped counteract the roughly 13 million barrels per day that had been lost during the war. And that new equilibrium could be sustained for quite some time, Kaneva argues. The market is functioning, albeit at a somewhat higher price.

JPMorgan isn’t forecasting a forever war. But if that happens, Kaneva says oil will likely settle around $87 a barrel — well below today’s levels. If the war ends, the bank suspects oil will fall much further to $64 a barrel.

Bob McNally, president and co-founder of Rapidan Energy Group, is more pessimistic. His forecast assumes this is a forever war — or what he calls a “spikey muddle-through” scenario — keeping Brent at $89 a barrel next year.

“We don’t see a full return of Hormuz,” said McNally, who was an energy adviser to President George W. Bush. “A forever war – by jeopardizing the world’s most important supply region – will accelerate the boom in oil and gas prices.”

Why oil may have to rise

Although the oil market has settled into a new normal, its patchwork project contains several weak spots that could fail if tested long enough.

The United States and China have relied heavily on their stockpiles of oil to cushion the blow from the war. They’ve held out far longer than expected. A critical storage facility in Cushing, Oklahoma, hit operational minimums in July, at which point physics no longer allows oil companies to easily pump crude through pipelines to deliver it to refineries. Yet Cushing’s reserves have recovered, rising slightly outside the danger zone in recent weeks.

China has very gradually increased its oil imports in recent weeks, but they remain millions of barrels per day lower than they were before the war. Few outside the Chinese government know how much oil the country has in storage, but it’s believed to be around a billion barrels.

At some unknown point in the future, those inventories will be depleted if the war goes on for an extended time, said Hamad Hussain, commodities economist at Capital Economics. That would cause supply and demand to enter an extreme imbalance, potentially sending oil prices much higher — exactly what most analysts thought would happen at the outset of the war.

Sinking inventories probably wouldn’t trigger an immediate price jump, but it would make oil prices significantly more volatile — not this year, but probably by late next year if the status quo holds, said Dan Pickering, founder and chief investment officer at Pickering Energy Partners. That’s because pipeline workarounds can’t be built fast enough, nor will new supply sources like Venezuela be able to adequately compensate forever, he noted.

Another key factor: US military sustainability.

“It’s not the hidden hand of the market. It’s the military finding a way,” said Helima Croft, who leads global commodities at RBC Capital Markets.

Croft, a former CIA analyst, stressed that the might of the US military is not inexhaustible.

“Are we forever in the escort service? That’s a heavy lift. These are costly workarounds.”

Croft suspects the war is stuck in a “grey zone conflict,” one marked by pockets of escalation sandwiched between periods of “difficult calm.” And she noted there is still a real risk of escalation, such as a repeat of the 2019 drone attacks on a Saudi oil field that sent oil skyrocketing.

How long could the war last?

One CEO of a major bank told CNN that the US-Iran conflict “probably is a forever war.”

“I’m not losing sleep over it, but we should be prepared for that,” the bank CEO said. “A forever war would leave everyone feeling edgy, but after a certain point you realize it’s just the new normal.”

US officials and researchers seem to be preparing for that scenario — or at least a longer-lasting supply shock.

Last week, the US Energy Information Administration concluded that oil exports through the Strait of Hormuz will remain “constrained” throughout the rest of the year.

S&P Global Energy went a step further, saying in a report that it no longer expects Middle East oil production to return to pre-war levels even by the end of next year.

“The market is not returning to calm,” said Jim Burkhard, S&P’s global head of crude oil research. “It is adjusting to the new normal defined by unresolved conflict and persistent maritime risk.”

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