Vessels at the Strait of Hormuz, as seen from Musandam, Oman, on Tuesday.Stringer/Reuters
Oil prices plunged again Tuesday, bringing the two-day drop to about 9 per cent after the United States and Iran reached an agreement on Sunday calling for an end to their war and the reopening of the Strait of Hormuz.
Oil markets are unwinding the war-risk premiums that drove up benchmark prices after the conflict erupted in late February, halting shipping in the critical waterway through which 20 per cent of the world’s oil and gas supply is normally transported.
Crude benchmarks Brent and U.S. West Texas Intermediate continued to slide Tuesday, dropping more than 4 per cent and hitting three-month lows, after losing nearly 5 per cent on Monday.
Markets are pricing in lasting peace from the U.S.-Iran agreement, but uncertainty is still clouding the oil’s outlook as details of the memorandum of understanding – set to be signed on Friday – are largely unknown.
U.S. President Donald Trump said the deal would reopen the strait and clear the U.S. naval blockade of Iranian ports. The strait is set to open after Friday’s signing in Geneva, he said.
Iran’s foreign minister said Tuesday that after the agreement is signed, Iran and the U.S. would start a new round of negotiations to reach a more comprehensive agreement in 60 days.
Stéfane Marion, chief economist at National Bank, said he expects oil to hover near the US$80 mark, cautioning that the market remains well above pre-war prices and that it will take time for prices to stabilize at lower levels.
“We don’t have the full disclosure on potential collateral damage that could impede oil production in the months ahead,” he said in an interview.
Oil supply from the Middle East has almost halved between February and May, according to a report from Capital Economics. While oil executives have said that output could be restored to pre-war levels in as soon as a few months, that goal could depend on several factors. Shipping traffic is expected to recover slowly as many vessels and insurers won’t be confident enough to sail through the strait while the threat of mines remains. According to Mr. Trump, the mines are expected to be cleared this week.
“The big questions are really about how quickly things can return to something like the flow rate through the strait prior to the war,” Kevin Book, managing director of research at Washington-based ClearView Energy Partners LLC, said in an interview.
Oil falls after U.S. and Iran agree to extend ceasefire and open Strait of Hormuz
Even if oil producers were able to operate at 80 per cent capacity, Mr. Book said it could take producers years to get back to pre-war inventory levels, a delay that could keep prices elevated.
“I think at least right now that looks like a reasonable expectation,” he said.
Demand dynamics have also shifted as countries began to source oil and raw materials from outside the Middle East, Mr. Book said.
“You might start to see a different shape of demand as importing countries look for ways to make sure this never happens to them again.”
While China’s crude imports have fallen over the last few months, there is increasing evidence that the major importer of Middle Eastern oil has been drawing on its reserves to weather the supply disruption. Around 45 to 50 per cent of China’s crude oil imports transit the Strait of Hormuz. If Chinese demand were to pick up again, the price of oil could trend back up.
The closing of the strait – which officially began March 2 – sent oil prices surging, creating persistent inflationary pressures that the Bank of Canada and other central banks have been navigating. While oil prices are forecast to trend lower if the ceasefire holds, the supply shock is expected to have lasting effects on the global economy.
“The impact on inflation will not disappear overnight,” Mr. Marion said.