On the Chop in the Oil Market

After Brent crude roundtripped the war-driven jump, recently renewed fighting has it popping up again with prices hitting $100 last week before receding to around $85 Tuesday as fighting paused—briefly.^[i] However, Brent was back over $90 Wednesday as attacks resumed. Predictably, seeing the steep upswing, pundits are rerunning fearful coverage from March and April, when oil’s piercing $100 led many to fret it would hammer the economy. Back then, we doubted oil would have the negative effects so many thought. We still do. Here is why.

Like in the springtime when the Strait of Hormuz shut, many now project worst-case scenarios. Back then, they feared there was no getting around the blockade. But this missed that Saudi Arabia’s East-West Pipeline could divert oil to its Red Sea port of Yanbu and export around five million barrels per day. In recent weeks, though, Iran’s Houthi allies in Yemen have targeted the East-West Pipeline, threatened Yanbu and struck ships transiting the Bab el-Mandeb Strait—the most direct route from Yanbu to the Saudis’ biggest customers in Asia. Pressure on this key global shipping lane turned what had been a major relief valve into another alleged chokepoint—a new front amid a seemingly widening war.

Meanwhile, as fighting resumed two weeks ago, “backwardation” in the futures curve for oil markets spiked, meaning prices for immediate delivery moved sharply higher relative to those further out along the curve. The bigger the backwardation, the more severely supply constrained the market is feared to be in the near term. Even with the latest outbreak after a brief war pause, though, backwardation has narrowed substantially, as roiling fears move to the backburner to simmer.

No doubt oil supplies remain tight—but that isn’t new; it has been this way for months. And remember: Anticipation is mitigation. Like we have already seen, supply disruption spurs adaptation. Consider Houthis’ Red Sea strikes in 2023, which caused ships to avoid the Horn of Africa and route around the Cape of Good Hope. That added to cost and delivery times, but commerce continued—although not ideal, it was less bad than feared. Yanbu is still an option for shippers, although traffic has reportedly cooled there amid elevated insurance rates. Presently, those wishing to avoid Yanbu can go to the Egyptian port of Sidi Kerir on the Mediterranean itself, where Saudi Aramco is increasingly sending export cargos. Eight supertankers were reportedly en route there Tuesday.^[ii] Now, tankers sailing north from Yanbu through the Suez Canal or just from Egypt do face a longer, more costly route to get to Asian customers. But again, in 2023, shippers took it. Moreover, today, shipments could go elsewhere (maybe Europe), freeing up global supplies to reach Asian customers from other producers. Regardless, the oil isn’t “off the market.” A change in global flows doesn’t a crisis make. Markets adjust and move on. They respond to incentives and adapt.

This follows the three-step process stocks typically trace amid energy-centric conflicts that Fisher Investments founder and Executive Chairman Ken Fisher outlined in March. First, volatility strikes and oil prices rise as pre-conflict saber rattling sows uncertainty. Second, the outbreak of fighting causes markets to price worst-case scenarios—oil surges and stocks drop. Third, markets fathom regional conflict’s limited, temporary economic footprint and realize long before the war ends that global growth will persist, allowing stocks to rally while oil prices fall.

We think step three arrived a while ago. The Iran war and associated oil shocks show steadily less influence over stock markets. In July, Brent crude rose as much as 46.9%, but global stocks barely budged.^[iii] It wasn’t news that the series of on-again, off-again ceasefire agreements were tenuous. So when war erupted again, it wasn’t very surprising. Surprises move stocks most. This war’s vicissitudes are by now pretty well understood by all. Yes, it can cause occasional chop—like bond market volatility that also drew attention, but that is part and parcel of oil jitters—and false inflation fears stemming from them. We wouldn’t expect such short-term swings to last.

For investors, the lesson here is clear: Think globally and don’t overrate oil’s impact. Keep in mind the US and EU use three-quarters to two-thirds less oil to generate the same amount of GDP than in the 1970s. Then, too, adjust for inflation and $100 oil is more like $75 in 2019 dollars, underscoring why there is nothing magical about $100+ oil today. If it didn’t upend global growth in April, why would it now? Or take $133 oil in the wake of Russia’s full-scale (and still ongoing) Ukraine invasion in late-February 2022—neither derailed the global economy. Nor did oil’s topping $100 from 2011 to 2014. Global supply chain workarounds continue to work. Oil hitting $100 per barrel, if it heads back there, just isn’t the threat so many people cast it as.