The oil market is moving into demand destruction mode

By Javier Blas

FIVE WEEKS into the Third Gulf War, the math of oil-barrel counting is intractable: The world is short of the black stuff. Measures ranging from pipelines that bypass the Strait of Hormuz to tapping strategic reserves have offered a cushion. But unless the US and Israel’s Iran conflict ends very soon, oil consumption needs to adjust to lower supply — perhaps much lower. Enter demand destruction.

Until now the market has absorbed the shortage of crude fairly well. Despite alarmist headlines, benchmark prices are hovering around $100 a barrel, well below previous crises when they surged to $130-$150.¹

This relatively muted reaction isn’t a sign that the market is underreacting to the closure of the strait, the waterway for a fifth of the world’s oil provision. Instead, it’s an indication that the layers of supply defenses have worked as a stopgap in a disruption that has lasted just a month so far. Previous crises went on for months, even years.

The gap between supply and demand is so wide that sooner or later these defenses will run out. The last time the market was so out of sync was in 2020 when the pandemic forced billions of people into lockdown. But then the problem was too much supply, this time it’s the opposite.²

In the first days of this war, the strait’s closure meant the immediate loss of 20 million daily barrels of crude and refined products. The industry went to work, activating a first layer of defense: using up stocks. The second layer came soon after as Saudi Arabia and the United Arab Emirates rerouted some exports using bypass pipelines to Red Sea and Gulf of Oman ports.

The third defense came from politicians. The richest nations tapped their strategic reserves, injecting millions of barrels into the market. . His jawboning about the chance of an end to the fighting helped tame panic buying.

Measuring the contribution from these various efforts is difficult. Some, like the pipelines, are permanent. Others, such as using up inventories, are temporary. suggests that, using generous assumptions, combined they’ve probably absorbed as much as 60% of the supply loss — or about 12 million barrels a day.

This still leaves a huge shortfall, which will get bigger if the war continues and reserves are drained. And there’s only one way to address it in the absence of fresh supplies, something I see as the market’s fourth, most drastic, defense: demand destruction. This is where policymakers use emergency tools to curb energy use (the less bad version), or where sky-high prices force consumers to stop buying (worse because of the blow to the economy).

You can see why this may be becoming unavoidable. As Paola Rodriguez-Masiu, chief oil analyst at consultancy Rystad Energy, puts it: “The system has shifted from buffered to fragile.”

How fragile? Very much, I’m afraid. If my math is right, the market needs to “destroy” demand by at least 8 million barrels a day or so. That’s more than the combined consumption of Germany, France, the UK, Italy, and Spain.

The better way to do this is through politicians forcing some reduction in oil use that, while painful, does less harm to business activity. Examples include lower speed limits on highways, and less use of heating and air conditioning. Mandatory work-from-home, thereby curbing energy-hungry commuting, is another option, though politically and economically more fraught.

The International Energy Agency has already recommended such measures, although no front-rank member has implemented them, fearful of the public backlash. In the developing world, however, countries including Pakistan, the Philippines, Vietnam, and Thailand are already going down this route. I expect many others will follow unless the war ends soon.

Unfortunately, there’s a limit to how far policy makers can manage demand destruction in an energy crisis with no end in view yet. Ultimately, soaring prices will play a significant part, and the impact of this will fall unequally. In Africa and parts of southwest and southeast Asia, refined petroleum products are already expensive enough to limit purchases, reducing economic activity. Chemical and fertilizer factories are closing down there.

Poorer nations will be priced out by richer ones or peers with the means to subsidize fuel prices and impose export bans.

Look at the distribution of the oil market: The US, Canada, Europe, Japan, and China account for nearly 55% of consumption. That means six out of 10 barrels of global use is in places that usually have the wherewithal to pay up. Most of the initial demand destruction is going to happen elsewhere in places that simply can’t afford the prices. The burden will be firmly concentrated in Africa, Latin America and much of Asia. Over the next few weeks, if the war continues, fuel pumps will run dry and factories will close.

If the war lasts months, rather than weeks, this will no longer be enough. The crunch will need to move where oil is truly consumed: the industrialized nations of the world. An : the scale of the supply disruption and its length. So far, the size is immense, but the timespan is short. For the sake of people’s lives in the warzones, and for both developing and developed economies, let’s hope the conflict is close to an end.

BLOOMBERG OPINION

¹ In real terms, adjusted by the cumulative impact of inflation, oil prices would need to rise even further to match previous crises. The nearly $150 a barrel all-time high set in 2008 is equal to about $220 a barrel in 2026 money, for example.

² Global oil demand in 2020 fell to an annual average of just over 91 million barrels a day, about 8 million barrels a day lower than the preceding year.