Oil and gas markets’ perilous dilemma

The on-off-on conflict in the Gulf continues to severely limit the passage of oil and LNG exports through the Strait of Hormuz. In the latest disruption, Iran has widened its geographical reach, enlisting its Houthi proxies in Yemen to disrupt around 4 million b/d of Saudi Arabia’s crude exports trying to passing through the Bab el-Mandeb Strait, its alternative route at the southern end of the Red Sea.

A few weeks of respite following the signing of the Memorandum of Understanding (MoU) between the US and Iran briefly allowed value chains to start cranking back up, and some rebuild of inventory. Now, however, oil and LNG markets are once again perilously placed, and the world is back to where it was before the MoU.

The dilemma confronting the two sides remains the same – a binary outcome with huge implications for the world: allow the conflict to fester and face dire economic consequences or strike a sustainable deal to unlock constrained supply back into the market. Time is of the essence. Alan Gelder, Head of Macro Oils Research, shared his latest thoughts on how things could play out.

No deal, global recession inevitable

Persistent – or, at least, sporadic – conflict in the Gulf and Red Sea constrain exports of crude and LNG (and other commodities) for months.

Oil and LNG value chains come under increasingly severe stress. Up to 12 million b/d of liquids (12% of the global production market) and 86 Mt of LNG production (20%) are shut in, amplifying risks of extended degradation through the value chains, including reservoir deterioration.

Global oil stocks are low, despite a few weeks of replenishment after the MoU. Crude and product inventory draw accelerates again in key markets. Visible inventories at Cushing are already near operational minimums, reducing the volumes of US crude available to export markets.

Upward pressure mounts on energy prices. Different seasonal factors are at play compared with earlier spikes, with late summer in the northern hemisphere traditionally the peak of global oil demand. China switching to tap its strategic oil reserves rather than pay up for crude imports at elevated prices only stalls the reckoning.

Brent futures return to the previous US$120/bbl peaks of March and April before climbing higher still. Demand destruction is the only means to ultimately deliver market balance.

Tight LNG supply, absent Gulf exports, threatens to leave European gas storage dangerously low ahead of winter. LNG prices rise to demand-destroying levels as importers, particularly in Asia, look to switch fuels to coal.

The economic outlook deteriorates as high energy prices push the global economy into shallow recession in H2 2026. Prolonged high prices persisting towards the end of the year plunge the world into a deeper recession into 2027, scarring the global economy.

Credible deal brokered, Brent slumps

A market reaction similar to the June signing of the MoU. Reopening export routes leads to Brent immediately falling off a cliff, investors bailing from positions that bet on higher oil and refined product prices.

A period of volatility ensues as the market assesses the sustainability of the deal, monitors the risk of flare ups and the likely variance between the speed of demand and supply recovery.

Fundamentals gradually reassert themselves, the oil market heading towards glut. There is no shortage of liquids once production and vessel flows normalise, supply recovery likely outpacing demand recovery even as strategic reserves are refilled. With the UAE out of OPEC and freed from production constraints, and the permanent removal of US sanctions on Iran’s oil exports opening up a wider customer base to support Iranian production growth, the market could be awash with oil.

Brent sinks well below US$60/bbl into 2027. A diminished OPEC+ needs to act decisively to avoid much lower prices that are a certainty if the group elects to compete for market share.

Routes to a deal

It’s far from obvious, even though each side has plenty of motivation to get back to the negotiating table and grind out a deal. For Iran, economic pressures will mount now export revenues allowed under the MoU have been lost. Among many other key factors Iran will want to gain, a nuclear solution close in substance to the Joint Comprehensive Plan of Action it signed in 2015 is a big one.

For the US, geopolitics is one thing, notably intensifying pressure from trade partners that are big hydrocarbon importers smarting from high oil and LNG prices. But the bigger issue – for politicians, at least – is domestic: specifically, prices at the pump. It is difficult to believe that the Republican party would relish contesting the mid-term elections in just 15 weeks with the conflict unresolved and gasoline prices at US$4/gallon or more.

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