Oil is the most important commodity in the world because pretty much everything runs on it. So it is not presumptuous to assume that the market is efficient. Well, I’m going to just say it: it is the most inefficient market today.

How so?

In a normal oil market, production outages (i.e. production shut-in) are barrels lost that can only be offset by demand destruction. No, not lower crude imports because that just drains crude oil inventories. No, not lower refinery throughput, because that just drains refined product storage. Demand destruction: end-user demand falls. Lower demand, lower global economic activity figures, lower mobility data, fewer flights, less traffic; you know, the stuff that actually tells you whether less fuel is being consumed or not.

COVID taught all the oil watchers one important thing: mobility indices. It’s pretty intuitive. To gauge whether oil demand was recovering, we just had to watch traffic, flight numbers, etc. Do we have similar demand destruction today?

No, not even remotely close to 10 million b/d.

So how is it that the oil market has convinced everyone that with each passing day, only escalation will push oil prices higher, and not just the production shut-in that should, in theory?

This is Pavlov’s oil market.

Pavlov’s Dog

Ivan Petrovich Pavlov was a Russian/Soviet experimental neurologist and physiologist known for his experiments with dogs. His experiment with dogs can be best summarized by this graph below:

In essence, if you train the dog to associate the neutral stimulus with food, the post-conditioned dog would associate the stimulus with food. Even without food present, the conditioned response would still show up.

Scott Bessent, the current US Secretary of the Treasury, used to be a hedge fund manager and worked under George Soros. To say that he understands the markets well would be an understatement. He knows that in a commodity like oil, price is king, and if traders get conditioned to think prices should gradually rise because we are losing 10 to 13 million b/d of crude oil production every day, people will panic, hoard crude, and drive prices higher.

The faster oil prices rise, the greater the economic pressure on the US, and the faster Trump would have to choose between a binary event: rapid escalation or full-on capitulation.

Clearly, it is not in the US national security interest for crude oil prices to go up. At the end of the day, even if we have a stupendously tight product market, product prices are still benchmarked to crude, so if you successfully suppress crude, you are suppressing product prices.

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I remind myself daily that I don’t know anything about geopolitics. That’s a fact. Instead, I try to make informed and educated guesses about what I see unfolding. While I am always reluctant to write about geopolitics, it is, unfortunately, necessary given the Iran war backdrop and its importance to the oil market.

So please bear with me.

On July 4, some of you may recall my memo titled “It’s Now Or Never.” The most relevant section in that memo was the following:

The Strait of Hormuz conflict is far from over. If you think about it from a game theory standpoint, it’s now or never for the Iranians.

Iran knows that if the US plays a war of attrition, it will lose 1,000 out of 1,000 times. You need the US to give up because of political pressure, and the easiest way to get that is through economic pressure.

We are now in the heart of the driving demand season. Global product inventories are low. SPR flow is running out. US commercial crude inventories are reaching levels at which US crude exports are shutting off. The rest of the world might have some barrels out of the Middle East that can last them through August or September, but what about after that?

What happens if China absorbs most of the barrels and there’s still 5 to 6 million b/d of production shut-in?

Most people seem to be paying attention only to what’s in front of them, not to what’s ahead. It’s like a man falling from a 40-story building, and you ask him if he’s ok on the 5th floor.

Yeah, he’s ok, but he’s not going to be in about 2 seconds.

We are not ok. If Iran contests the Oman route, that’s an estimated ~6 million b/d of flow that will be cut off. UAE, which saw exports surge to ~4 million b/d in June, will drop back to ~2 million b/d. The rest of the Middle East won’t be able to get the flows out in a manner that they like. Meanwhile, Iran will keep exporting its ~2 million b/d as if nothing happened.

But the US can never let that happen. The US can never let Iran control the Strait of Hormuz, because if it does, it will be able to hold the rest of the world hostage. So the only way out is through escalation, which is all but certain to make things worse before they get better.

That’s reality.

From a timing perspective and with the benefit of hindsight, early July was the pivotal all-or-nothing moment. The now or never title was meant to signify that all the stars were aligned, and coincidentally, that’s also when the escalation reached the current fevered pitch.

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I am down, but I am not out. My July 17 call options went to call heaven today. May you rest in peace. I thought I gave myself enough time, I clearly didn’t.

When a trade seems too good to be true, it usually is. I don’t think I could have seen the price action even if you had told me what the future entailed. If I had only the geopolitical events handed to me, but not the price chart, I would never have expected Brent to remain below $90/bbl despite both the US and Iran returning to all-out war.

But my experience in oil trading has taught me enough humility to expect the unexpected, and while I took on a lot of risk in my personal trading account, I did practice prudence in the broader portfolio.

In this quick update, I want to share how I’m thinking about the oil trade and the portfolio.

Thoughts

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I believe the oil market is mispriced. Crude is mispriced. Products are mispriced (crazy to believe), and refining margins are masking the underlying issues.

It appears to me that because the “invisible hand” has no way of printing barrels and preventing product prices from going up, the market, the efficient part at least, has been screaming that we have a product shortage.

The 3-2-1 crack spread is sitting near $70/bbl, the highest in history.

Note: Divide it by 3.

And before people start talking about the lack of refining capacity, it’s important to preface some of this with context.

There are currently ~7.5 million b/d of refining capacity outage. Last year, we averaged ~3.5 million b/d of capacity outage.

Normally, we always lose some refining capacity because of operational issues. That’s the nature of refineries. They are fixed beast animals, and while the intent is to keep them operating near full capacity at all times, they can’t. That’s why you undergo seasonal maintenance to reduce the risk of unplanned outages.

Now, some of these refining outages are done on purpose (China), and some of them are by external factors (Middle East + Russia). In total, we have ~4 million b/d of refinery capacity offline compared to last year. Is it possible to replace this?

Absolutely.

Where?

China.

China has so much refining capacity today that if they really wanted to, they could increase throughput by ~7 million b/d (assuming they can get the crude). The issue for China is that running throughput at ~19 million b/d wouldn’t do it any good, because product exports average only ~1 million b/d per month.

For China to fully utilize its refining capacity, it would need to ramp up product exports to ~4 million b/d per month, up from 1 million b/d. That’s unlikely, given that China’s excess refining capacity was built for national security rather than economic reasons.

China learned from what happened to Japan in World War 2. In order to prevent an oil embargo, China needed vast amounts of crude oil in reserve, and since petroleum products have a shelf life, and crude doesn’t. The only solution to the product issue was to build excess refining capacity.

Now, can China save the world? Yes, absolutely, but it would have to do something it never did before, increase product export quotas.

Geopolitically speaking, does China really want to save the US from the current product shortage? Unlikely, so we are now stuck in this weird world where product prices are mispriced because crude is mispriced, but refining margins are the only real signal here.

An interesting dynamic indeed.

Where are we headed?

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It is close to impossible to write any in-depth piece when the information flow is overwhelmingly volatile. Following our write-up titled, “The Consensus Is Wrong About The Oil Market.” Iran fired at more ships that were trying to transit the Oman lane under US protection. And after the stock market closed, of course, the US responded by attacking Iranian targets along the Strait of Hormuz.

The latest news flow is that Trump and the Iranians are saying that the MOU is dead. Whether that’s true or not is yet to be seen, but what’s abundantly clear from all of this is that there is no diplomatic resolution to the Strait of Hormuz issue.

Since the start, I have assessed the geopolitical situation as all-or-nothing. Either Iran controls the Strait of Hormuz or it doesn’t.

But what’s more interesting for the global oil market isn’t the tit-for-tat in the Strait of Hormuz; it’s that China just lifted its product export ban.

Why is this meaningful?

In a write-up I published on June 25 titled, “We Are ‘Still’ Going Full Speed Into The Wall.” I said:

Funnily enough, China can now rescue the world again, but in reverse.

First, China saved the whole world by not buying crude (starting mid-April). The lack of crude buying allowed other Asian countries to access the barrels they needed during the pivotal summer demand months. But remember that the Persian Gulf also sent a lot of products out to Asia and Europe, so China can only help on the crude front, and not the product front since it banned petroleum product exports for the sake of national emergency.

Now that the world is running low on product inventories ahead of peak demand season, a big reason why cracks keep outperforming, China can rescue the world again by lifting the product export ban.

With teapot refineries operating at 50% utilization, China is the only country in the world with excess refining capacity right now. Teapots, in particular, can help resolve a chunk of the upcoming refined product shortages.

And since China has been willing to rescue the world so far from the crude shortage, it may very well rescue it again with its excess refining capacity.

Now does this mean that refining margins will collapse?

Unlikely given how low inventories are right now. This is especially true if the US starts to keep products at home due to the low storage.

But the only way China can actually help resolve the issues in products will be to buy crude again. So the current crude surplus is very temporary, given that inbound tankers into the Strait of Hormuz remain a trickle and the production shut-in has no timeline for restarting.

For those of you who have followed the oil math from the start, it’s very straightforward:

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I’m not going to mince words here. This article is not meant to be an in-depth write-up. I had previously planned to write up the oil math needed to get production shut-in to return, but after two tankers were attacked on the Oman route, it is clear that the Oman lane will be heavily contested in the coming days/weeks.

For those of you not familiar with the oil math from the start, I will just do a quick recap.

Following the Iran conflict, there are two bypasses:

• East-West pipeline: 7 million b/d, 4 million b/d of export capacity in Yanbu.

• Abu Dhabi pipeline: 1.8 million b/d.

During the month of May, UAE started doing shadow transits which boosted crude exports to ~4 million b/d in June. Fujairah is now exporting majority of the oil for Kuwait, Iraq, and Saudi through ship-to-ship.

The issue here is that the Oman route is estimated to handle 6-8 million b/d of crude inflow and outflow. Since June 17, Energy Aspects estimates that 150 million bbls have exited the Strait of Hormuz. This equates to a flow of ~8 million b/d. Including bypasses, this puts flow at ~13 million b/d, still ~5 million b/d short of pre-conflict levels. The other 2 million b/d is associated with Iran, which is also having difficulty getting tankers to return to load crude. It first needs to offload the crude, wait for the tankers to come back, and then gradually restart production.

Now that tensions are rising again in the Oman lane, any assumption that the Strait of Hormuz traffic flow will return to normal is just wishful thinking. As I soberingly explained in my piece on June 23 titled, “The Strait Of Hormuz Isn’t Going Back To The Way It Was.” We aren’t going back.

Either Iran controls the Strait of Hormuz or it doesn’t. There’s no in-between.

A Normal Strait? No Way

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The Iran conflict is a game played by giants; we (oil traders) are nothing but ants stuck in a field full of giants.

The goliath in this case is the US and China. From the start, my analysis of the Iran conflict was that the longer the conflict lasts, the lower the probability of a smooth resolution. Despite signing the MOU nearly 2 weeks ago, Strait of Hormuz traffic remains at a trickle compared with pre-conflict levels, and oil production shut-in in the Middle East continues at ~6 million b/d, excluding Iran.

But the world has found itself in an interesting predicament. It is currently short of products and has a surplus of crude.

So before we get started with the main topic today, let’s do a quick recap of the oil math.

Oil Math

Goldman’s latest update on June 29 did a good job of recapping some of the recent updates:

The first chart is the Persian Gulf flow, including bypasses from both Fujairah and the East-West pipeline. Relative to pre-conflict flow, this almost returned to normal until Kiku, the VLCC, was attacked.

Excluding the bypasses, you can see that the flows were nearly normalized, thanks largely to stranded tankers exiting before stalling again.

This can also be viewed from Windward AI, which shows a jump in traffic before falling.

Source: Windward AI

On the inbound tanker side, we have kept a tally of all visible AIS tankers entering.

What should be clear from the list of tankers is that, following the IRGC attack on Kiku, most tankers have only traversed the Oman route under US escorts. Excluding dark transits, we have averaged ~3 VLCCs per day. Including dark transits, we are perhaps closer to 5.

To further break this variable down, the current estimate for the last 7 days of inbound tankers has averaged 6.3 million b/d.

Iran - 2 million b/d

UAE - 1.4 million b/d

Saudi - 1.4 million b/d

Iraq - 1.1 million b/d

Kuwait - 0.3 million b/d

Now, in relation to the oil production shut-in math, if these variables were to continue, this is what the production shut-in would look like:

Iran - assuming normal

UAE - assuming normal

Saudi - 2 to 2.5 million b/d shut-in

Iraq - 2.2 million b/d shut-in

Kuwait - 0.65 million b/d shut-in

Bahrain - 0.17 million b/d shut-in

Qatar - 1.1 million b/d shut-in

Total: 6.12 to 6.62 million b/d

In historical terms, if this were a normal oil market, it would still be the largest oil production outage in the market’s history. But this is far from a normal market, and this brings me to the point of this article: we are but ants in a field full of giants.

China, single-handedly, eliminated the entire crude oil deficit by reducing imports.

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Please read part 1 of the report.

“Dude, you must be crazy.”

I probably am, but we are still going full speed into the wall. Yes, WTI is barely hanging on to $70 for its dear life, but please remember that consumers use petroleum products like gasoline and diesel; they don’t use crude oil. Refineries do, and this is why it was always important for us to pay attention to crack spreads along with crude timespreads.

Note: Please divide it by 3.

The fever in the market today is that crude is oversupplied, but products are undersupplied. How can this be possible?

Well, China’s June crude import data so far is -4.7 million b/d y-o-y, and teapot refineries are operating at 50% utilization. Compared to US refineries operating at 95% and PADD 2 refineries operating over 100%, you can see where the disconnect is.

But here’s the thing. If end-user demand isn’t down and you still have a production shut-in of ~8 million b/d, you are losing barrels in one form or another. Yes, China might not be importing crude, but it is drawing down product inventory. No one has visibility into how much China has in products right now, but it can’t be far from very low levels.

The same could be said for product inventories across the globe. Elevated crack spreads are a sign that despite higher refinery throughput in the coming weeks/months, the world still doesn’t have enough products. You can see this in the price action in the spreads.

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The market is incorrectly assuming that the Strait of Hormuz will return to normal. Since the beginning of the Iran conflict, I saw this geopolitical event as all or nothing. Either Iran comes out victorious and controls the Strait of Hormuz or the US succeeds in toppling the regime and restores the Strait of Hormuz back to normal.

There was no in-between.

Now that the MOU is signed, effectively giving Iran control of the Strait of Hormuz, we are never going back to the way it was. Unless, of course, the US tries to restart the conflict and comes out victorious, but outside of this scenario, Iran is now the most powerful oil producer in the world.

It has been a week since the MOU was signed and the latest tanker traffic data is becoming obvious. Following the conflict in Lebanon over the weekend, IRGC announced that it stopped issuing permits and the current tanker activity exiting the Strait of Hormuz is related to existing permit holders.

Over the coming days, this will become obvious. But what should be even more glaringly obvious right now is the tankers coming into the Strait of Hormuz.

Since the announcement of the closure over the weekend, these are the tanker inflows for the last two days:

From a total vessel count, most analysts are looking at the bigger headline figures:

Source: Windward AI

But for the relevance of the oil market, production shut-in, we need to see sizable volumes of VLCCs going back into the Strait of Hormuz to change the math. At this moment, that is not happening.

Going forward, I will be publishing daily tanker counts, just like the table above, distinguishing between sanctioned and unsanctioned tankers and their types. That way, readers can see the emerging pattern, which is becoming obvious to me.

IRGC controls the Strait of Hormuz, and the inflow of crude-related tankers right now is dominantly going to Iran, with some leakage here and there for the others.

In my view, anyone assuming the Strait of Hormuz will return to normal is making a serious analytical mistake. This is especially true given the data that’s surfacing right now.

Variant Perception

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I am happy that we can finally start modeling out some clarity in the oil market. MOU on, MOU off was starting to get rather tiresome with the entire oil market swinging back and forth on the conflict rather than the inventory draws.

In this piece, we will use a June 19 reopening as a base case for what the oil market looks like.

June 19 Reopening

Media outlets are reporting that on June 19th, Iran and the US will sign an MOU to start discussions on the various points. The MOU has not been published, and we do not know if there will be “toll-like mechanisms” attached to the reopening.

From my standpoint, it appears that the signing by June 19 is a test to see whether Israel can actually pull its forces away from Lebanon. That’s an entirely separate discussion that will not be covered here.

Instead, we will just look at the oil math on a June 19 reopening.

So where do we stand?

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There’s a funny distinction amongst oil specialists. There are the guys who solely do research, and there are the guys who only trade. I guess HFI Research is a bit unique here in that we trade oil and publish research. So yes, we put our money where our mouth is, unlike many research firms out there.

In my decade-long following of the oil market, I have never seen it this mispriced. In this article, I will detail my variant perception and why reality will hit the market like a sledgehammer.

Variant Perception

• HFI Research is the only research firm that publicly publishes EIA weekly crude storage estimates. Because of this unique edge, we are able to pinpoint “when” US commercial crude oil inventories will reach distress levels (i.e., operational minimums, ~380 million bbls, late July).

• Even if the Strait of Hormuz reopens today, we need empty VLCCs to return to the Persian Gulf to alleviate the onshore storage, which would allow Saudi, UAE, Kuwait, Bahrain, Qatar, and Iraq to start returning production shut-in. If the Strait of Hormuz reopens this very second, production shut-in won’t return for another 6 weeks (optimistically), which would guarantee further supply loss.

• China has reduced crude imports by ~3.5 million b/d, but that has only partially offset the ~11 million b/d of supply shut-in. Even if China does NOT return to the oil market, oil inventories in the West will reach operational minimums (i.e., tank bottom).

• The velocity of the SPR release will slow materially by the end of June. Government intervention policies are running out of steam, which means commercial oil inventories will feel the full force of the supply outage. US commercial crude inventories over the last 6 weeks have already seen 3 of the largest crude draws since 1982.

• Geopolitically, the Iran-US conflict is all or nothing. Either the IRGC is in control of the Strait of Hormuz or the regime is toppled; this binary scenario all but guarantees a prolonged conflict, contrary to market participants’ belief of a swift resolution.

With that, let’s talk about the mispricing.

Mispriced

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In the past 2 weeks, observable oil inventories (satellite, oil-on-water, and EIA) declined by ~121 million bbls. Goldman published a note today also verifying the increase in visible oil inventory draws with an average of 8.7 million b/d for May.

The math is what it is. Even if the Strait of Hormuz had reopened back in mid-April, these visible oil inventory draws were inevitable.

The Math

First, we need to understand the sequencing.

• Production shut-in results in lower crude exports.

• Lower crude exports result in lower crude imports.

• The initial loss in crude exports push oil-on-water lower. But as other segments of the market boost exports (the US), oil-on-water moves higher.

• But given there’s no production restart because the Strait of Hormuz is still closed, oil-on-water is now falling again, which will push onshore oil inventories lower.

This is precisely what we are seeing in oil-on-water. Higher US crude exports will be insufficient to fill the gap.

Why?

Global crude exports are lower by ~6 million b/d in May vs last year. That’s with the US averaging 5.6 million b/d this month, or +2.1 million b/d y-o-y.

What most people may not realize is that the current export trend in the US is completely unsustainable. This week’s EIA oil storage report saw the largest crude oil inventory draw in history, and slightly lower than what we had projected. By July, US commercial crude storage will hit an operational minimum, and the market is already starting to price out US crude exports.

We estimate that the US can average ~4.6 million b/d without excessively draining crude oil inventories, which means the rest of the world will see another ~1 million b/d reduction in flow.

By July, the y-o-y global crude flow deficit will hit ~8 million b/d.

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On April 25, we published a piece titled, “B.A.C.D Is Coming To An Oil Storage Hub Near You.” In it, we said:

From now to the end of July, visible US crude inventories will decline by ~213 million bbls, the largest and fastest decline in history.

US total liquids with SPR will fall to an all-time low.

Yes, an all-time low.

Since EIA started publishing the data in Jan, 5, 1990, US total liquids have never breached 1.4 billion bbls.

This is happening regardless of what happens to the Strait of Hormuz. It’s too late already.

Fast forwarding to today, we are on pace:

US Total Liquids With SPR

In our April 25 report, we wrote:

Starting in next week’s EIA oil storage report, the US will average over 18 million bbls in total liquid draws.

Since then, US total liquids with SPR dropped 48.846 million bbls. We have averaged a draw of 16.282 million bbls per week.

Looking at current projections, US commercial crude storage is expected to decline steadily through the end of July. Refinery throughput has picked up, which will dampen some of the product draws we’ve seen, but crude draws will remain very heavy.

As you can see from the current product storage chart in the US, we are already running low on available products for domestic consumption.

In 2022, we had a global refinery capacity shortage, which saw refining margins rise disproportionately relative to crude. US refineries were incentivized to run at full capacity all year. You can see in the green dotted line above how low product storage stayed throughout 2022.

This time around, we have a crude shortage, but the lack of crude elsewhere has incentivized US refineries to run at max capacity going into the peak driving season. Product storage is now ~13 million bbls from the lows we saw in Q3 2022. We are about 3 weeks away from US petroleum product exports falling. Once the buffer is gone in the US, the elevated petroleum product exports that the world is enjoying will disappear.

Time is running out.

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There was a rude awakening in the oil market today. EIA reported a monstrous 24.1 million bbl decline in oil inventories. SPR release was 7.1 million bbls. US commercial crude storage declined 6.2 million bbls.

As we explained over the past 2 weeks, visible oil inventories will start to plummet. Today was just a preview of the many more inventory draws ahead. The crazy thing is that even if the Strait of Hormuz opens this very second, the incoming oil inventory draws won’t stop due to the logistical timing issues we explained here.

In this article, I will answer the following questions:

• What does the sequencing look like? (What happens first, etc)

• What happens to oil prices?

Sequencing

Let’s start with sequencing because there’s a lot of misinformation out there.

The Strait of Hormuz closure is impacting crude flows more than product flows.

Now I’ve seen some generalists bring up the comparison to 2022, so this needs to be cleared up first. In 2022, there was a global refinery shortage. Due to mandated COVID stay-at-home policies from 2020 to 2021, global refinery throughput declined structurally. Following Saudi’s oil price war in March 2020, the historic OPEC+ production cut that began in May 2020 led oil inventories to normalize by the end of 2021.

As Russia invaded Ukraine in March 2022, the global oil landscape was already tight on products, so the fear of sanctions on Russian oil led the market to panic over concerns about products. This was most notable in diesel. And since the world was short on refining capacity and no crude supplies were lost, refining margins took the bulk of the price increase, while crude lagged. This is why you never saw Brent surpass $125/bbl.

To summarize: 2022 was due to 1) low global oil inventory stockpile, 2) shortage of refining capacity, and 3) no loss in crude supplies.

It’s important to understand this framework because it will help you understand the sequencing I’m about to explain.

The Strait of Hormuz closure is resulting in an 11 to 12 million b/d loss of crude. Here’s the breakdown by country:

• Saudi: 3.5-4 million b/d

• UAE - 1.75 million b/d

• Iraq - 3.5 million b/d

• Kuwait - 2.35 million b/d

• Bahrain - 0.18 million b/d

Total shut-in: 11.33 to 11.83 million b/d.

You will see others talk about the product flow outage, but to be conservative, I’m just assuming it gets replaced by refineries outside of the Middle East.

Asia is the most dependent on this crude supply. Following the Strait’s closure, we saw China ban the export of products. This immediately sent Asian refining margins higher. This was the first event in the sequencing.

Asian refineries outside Japan, South Korea, and China do not hold sufficient crude in stock to last more than 2-3 months. The immediate impact is that if there’s no flow arriving, refineries have to reduce throughput. This, coupled with China’s ban on product exports, kept refining margins high.

But again, the main shortage here is crude, so while refining margins gained initially, it’s not the segment that will gain the most.

My analysis indicates that global refining margins have already peaked. Refineries are now exiting maintenance season, so every refinery is incentivized to maximize throughput.

Based on the current refining margins, crude can rally another $20 to $25 per barrel. This will squeeze refining margins, so refineries with insufficient crude will throttle throughput again. If end-user demand can absorb higher product prices, margins will rebound once throughput is reduced, and the cycle will rinse and repeat.

In essence, refining margins will bounce back and forth from here on out, while crude is going to stay in an uptrend. Unlike 2022, most of the upside this time will be in crude.

For the time being, we are far too early in this cycle to be looking for the “turning point”, but as I explained in this article, we have all the signals in place.

What’s Next?

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Since the Iran conflict began, many barrel counters have been able to pinpoint precisely “when” onshore oil inventories would start falling. No, it’s not because we have crystal balls. It was simply because we gave a damn.

As I explained in an article published on March 4, 2026 titled, “Why Aren’t Oil Prices At $100?“ We wrote about all the “cushions” that had to be absorbed before onshore inventories started to plummet.

Well, we are here. (Note: Please also read, “The Oil Market Breaking Point Is Here.”

B.A.C.D is coming. Big ass crude draws, and they will break the record books.

And before I continue, I want to give you an analogy. This analogy is important because it highlights what I think is going on.

Natural gas community vs the generalist

There’s another niche group that we belong to: the natural gas community.

In this particular group, we follow weather patterns, heating degree days, cooling degree days, wind, pipeline flow, and all sorts of weird data. Generalists understand better not to traverse the world of natural gas. It is the sector where generalists come to die.

Every winter, specialists in the natural gas world are keenly watching changes in weather models, particularly the one model that rules them all, ECMWF-EPS. This is the European Ensemble model, or, as it’s aptly nicknamed, King Euro.

The weather model updates four times a day, but there are two main updates, the 00z and 12z. I won’t go into the technicalities of the model, but just know that every time this is updated, natural gas prices surge or drop based on changes in heating demand.

The natural gas market has adapted to the fast-changing pace of real-time information. There are billions of dollars moving within seconds as the data changes, so the price is somewhat efficient.

But every once in a while, there’s a weather event so shocking that the model fails to price this all in at once. This was most notable at the end of January this year when a record-breaking cold blast came.

For natural gas, the proverbial “cold blast” is the one thing that would send prices to the moon.

So, if we put the current Strait of Hormuz oil outage in natural gas terms, it’s like the coldest weather event in history, lasting 66 days. And since natural gas demand is measured in real-time, the whole world can see it and price it immediately. Spot cash prices surge, demand is needed immediately, and the financial market reacts.

But the oil market hasn’t done that yet. Why?

Well, here’s your answer.

BACD: Big ass crude draws

On April 11, we published a report titled, “Making Sense Of The Oil Market.” It was hard to understand why oil prices aren’t reflecting the incoming draws we are seeing. Most energy specialists with experience in natural gas know that if projections show a large deficit coming, markets should price it in, right?

Well, the market was inefficient. BACD is here now.

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This is the first time in a decade since I’ve specialized in energy that none of the energy specialists are in disagreement.

First time.

This point is important to understand when analyzing the oil market because in a normal market environment, oil prices are sensitive to small changes to the balance. If you have been building oil supply & demand models as long as I have, you might get disagreements between 0.5 to 1 million b/d at most.

Coming into 2026, IEA had projected a surplus of 4 million b/d, while others projected a surplus of 2 million b/d. This was considered the largest difference in forecasting ever.

Think about that for a second. It’s 2 million b/d; how much can you really argue about here?

A lot, actually. And this is where the generalists just have no idea when it comes to the oil market.

You see, commercial inventories are not really all commercially available. US commercial crude storage has a headline number of 460 million bbls, but it’s not really 460 million bbls. Roughly 135 to 155 million bbls of that is in linefill, volumes needed to keep pipelines flowing. And then you have operational minimums, volumes required to keep storage working.

The reality is that US commercial crude storage has a tank bottom near 370-380 million bbls and has a tank capacity of 540 to 570 million bbls. The margin of 160 to 200 million bbls is all you can play with.

So when you talk about a 2 million b/d surplus, that’s a lot. Over 365 days, that’s a build of 730 million bbls. Without buying from China, this type of surplus can easily push commercial crude storage towards tank tops. This is why during the COVID lockdown, oil prices responded so swiftly to the downside. A 15 million b/d demand outage, coupled with the Saudis launching an oil price war, all but guaranteed that other producers had to shut-in production to prevent storage from hitting max.

And this brings me to the point of this article: none of the energy specialists disagree on the “math” because the deficit is so large; the minuscule details we used to argue over are no longer relevant.

If you miss the current balance by as much as 2 million b/d, you are really not missing all that much. When global oil production shut-in is as high as 13 million b/d, whether it’s 9, 10, or 15 million b/d becomes irrelevant.

Oil market balances are extremely sensitive to imbalances of just 1 million b/d, let alone a supply outage of 12 million b/d. You have to be in the oil market to understand that, and very few generalists appreciate this fact.

So it’s not fear-mongering when everyone in energy is screaming at the top of their lungs that there’s a crisis coming. Because it is what it is.

Heavyweights Agree

There are 3 independent heavyweights in the physical oil trading business: Shell, Vitol, and Trafigura. Combined, the 3 heavyweights trade ~27 to ~28 million barrels per day. In global oil supply terms, they are ~26% of the market.

So when the math of 1 billion bbl supply loss gets validated by both Vitol and Trafigura, you can imagine the smile on my face.

Vitol

Trafigura

And once again, this brings me to my point: there’s never been a point in my career when everyone specializing in energy agrees on the magnitude, while the market disagrees.

This is the first.

Market Implications

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My advice to you is simple: follow the signal.

As I’ve said recently, the math is what it is. Generalists can believe whatever headline or narrative that’s being touted, but oil inventories will decline. Whether they will only believe it when it “shows up” or whatever is up to them. I’m not here to hold the market’s hand. I’m here to make money.

Where are we on the oil storage math?

As I’ve been saying since the start of March, the excess oil-on-water drained first. This is gone now.

There’s a minimum volume required for oil-in-transit. So you should not expect this to nosedive any further unless the Strait of Hormuz remains closed until the end of May.

Onshore crude oil inventories are starting to follow suit.

On the surface, this looks like we are still in surplus, but that’s not really the case.

China holds the entire surplus in storage. As I’ve said, this is a national security concern, so China will continue to hoard crude and ban product exports. The product export ban has jacked up Asian refining margins, and sadly, that’s still not enough. Without those teapot refinery product exports, Asia will run low on products in 3 weeks.

As for the rest of the world, the onslaught of the draws is about to hit storage with full force.

Even if the Strait of Hormuz opens this very second, the draws will continue until August. There’s nothing anyone can do about that at this point. The math is what it is.

What about crude exports?

Global crude exports are down ~9 million b/d y-o-y. The data is now confirming all of the math the oil specialists have done over the last month.

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We have a lot of ground to cover in this update. Here’s what happened this weekend:

• US and Iran failed to reach a peace agreement.

• President Trump announced today that the US Navy will form a blockade to prevent Iranian ships from passing through the Strait of Hormuz.

Anyone who reasonably expected Iran and US to reach a peace settlement at a meeting over the weekend must not have studied the previous Nuclear Deal signed into place under President Obama. The Iranians are infamous for being tough negotiators, and with the Strait of Hormuz traffic under their control (for now), they will push this advantage to the end.

As for the negotiation, there were 3 sticking points that will continue to pose as major issues going forward:

• The US rejected any notion of a toll fee arrangement from the Iranians and demanded that the Strait of Hormuz be reopened immediately. Again, we have discussed this in depth in this write-up. The notion of a toll fee arrangement is a non-starter for the GCC. Yes, you can have a gradual reopening, which prevents shut-in production from returning, but you cannot have a gradual reopening with a toll fee.

• The US demanded that the Iranians hand over or sell their entire stockpile of near-bomb-grade enriched uranium. No agreement on that front.

• The Iranians demanded that $27 billion in frozen revenue held abroad be released. In addition, Iran sought reparations for damages.

In my view, the Strait of Hormuz issue will be the biggest sticking point going forward. As I’ve written numerous times, the bogeyman is out; the Iranians have now played their ultimate trump card. To relinquish this advantage is to admit permanent defeat in the future. This is one bridge they will not cross, no matter what.

For the US, the move to blockade traffic in the Strait of Hormuz will be difficult to execute. We have more questions than answers at this point, so let’s dig deeper.

Impact on the Oil Market

On the blockade, here are some questions we have that will need to be answered:

• What is the enforcement mechanism if the vessel conveys a different destination? GPS spoofing is common knowledge amongst the shadowfleet tankers. Is the US Navy just going to stop every vessel that’s currently on the sanction list?

• Will the blockade cover the Jask terminal, where Iranians can divert crude oil production from Kharg Island? If so, how will the US Navy respond to ground forces launching missiles and drones at the ships?

• Will the US Navy get into a confrontation with Chinese vessels? If so, what are the ramifications there?

For the oil market, here are some of the facts:

• Iran currently has ~170 million bbls in floating storage/oil-in-transit. Despite the US lifting sanctions on Iranian exports, Iran has been slowly depleting this stockpile. At $135 per barrel (physical market prices), Iran’s floating storage is worth $22.95 billion. This will buy it some time to deal with the blockade (assuming it’s effective).

• The US blockade, if effective, would choke off Iran’s crude export, which is estimated to be ~1.6 to ~2 million b/d. This would increase the global oil supply outage to 12.6-13 million b/d.

Another important ramification for the global oil market is that the Bab el-Mandeb Strait, which is responsible for Saudi’s entire crude export volume from Yanbu today (4.5 to 5 million b/d), could be disrupted by the Houthis. If this chokepoint develops, global supply would be out by 17 to 18 million b/d.

At this point, the oil math is impossible to fathom. The scale of the supply disruption is the equivalent of the demand disruption we saw at the peak of COVID. To balance the global oil market, prices will need to reach a level that matches the level of activity reduction we saw in 2020.

At some point over the coming weeks, countries with insufficient storage capacity will have to impose the same degree of lockdowns. This is when the physical oil market will escape reality and enter into fantasy land.

I suspect in the coming weeks, sellside analysts will have to start asking the question: how high do oil prices have to go to balance ~13 million b/d of supply disruption?

Note: Please read our article: Oil Demand Destruction Is Coming, It’s Too Little Too Late.

It’s anyone’s guess now, but I can tell you this with confidence: it’s not $150/bbl, it will have to be a lot higher.

Why aren’t oil prices higher?

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We have three high conviction views on the oil market today. These are:

• If the Strait of Hormuz does not return to normal, oil demand destruction via materially higher prices will rebalance the market.

• If the Strait of Hormuz returns to normal this very second, production shut-in (~11 million b/d) will not return to normal until the end of June at the earliest.

• If Iran imposes a toll fee arrangement, Saudi Arabia and the UAE will continue to bypass crude exports via the East-to-West and Abu Dhabi pipeline. This will keep ~4.7 million b/d offline. Here’s our explanation for why.

In our public write-up published on Tuesday titled, “The US And Iran Ceasefire And What It Does To The Oil Market.” We explained in detail the math behind our conviction point #2 above. The market’s problem going forward is that, with each passing day, there’s no complete resolution to the Strait of Hormuz or the production shut-in, onshore storage is falling.

Using the latest tanker-tracking data, this is our updated estimate of US commercial crude storage by the end of June.

Tanker activity shows that US crude exports are about to explode past ~5 million b/d. This explains, in part, why Brent-WTI spreads have started to meaningfully collapse.

Once US commercial crude storage falls close to ~400 million bbls, Cushing will have reached close to operational minimum. This is when we will see WTI timespreads explode. We are already seeing Brent physical prices gap $30+ higher, and it’s only a matter of time before financial markets catch up to the physical reality. There won’t be any market manipulation attempts there when we run out of the onshore inventory cushion.

All of this leads us to believe that the only way the market can effectively balance everything is via demand destruction. So what are the signals?

Signals

Refining Margins

The first and most obvious signal for demand destruction will be when global refining margins turn negative. We all know that the majority of the supply outage today is in crude. There are ~11 to ~13 million b/d of production shut-in that won’t return anytime soon (logistical timing). To grasp the intensity of the supply outage, just imagine that during the height of the pandemic lockdown, global oil demand fell by ~10 to ~15 million b/d.

In other words, if the global economy returns to COVID-style lockdowns, you “might” be able to balance the current supply outage.

To get a sense of how all of this will unfold, we just have to use historical examples to grasp the timing and nuances of events.

Let’s use COVID as an example. Here is the sequence of events:

• Lockdown imposed.

• Staying home mandated.

• Product inventories build.

• Refineries cut throughput.

• Crude inventory builds.

• Floating storage builds.

• Prices drop below the operating breakeven.

• Production shut-in.

Those were the initial steps; the rebalancing looked like this:

• Lockdowns ease.

• Mobility indices increase.

• Product inventories decrease.

• Refining margins rebound.

• Refinery throughput increase.

• Crude inventory stops building.

• Floating storage starts to decline.

• Prices recover back above the operating breakeven.

• Production shut-in gradually returns.

Now that you understand the logic chain, here is what’s happening today.

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By: Jon Costello

There is clearly no shortage of Hormuz commentary right now. In making my own contribution, I feel a bit like the author of a self-help book who has to justify his addition to an already oversaturated genre. What I can offer is an article focused on supply math. Most commentary focuses on the geopolitics, such as who said what, which side might blink first, or what an off-ramp might look like. Many fall into the trap of estimating resolution timelines and then pricing backward from that assumption. In this article, I examine the physical market disruptions and their implications for oil and refined product prices.

What becomes obvious is that the market is too complacent about the Strait of Hormuz.

This is not a geopolitical call; rather, it’s implied by the supply math. Regardless of the diplomatic signaling of the moment, the physical supply deficit and logistical realities dictate that this disruption extends through April at minimum, with the likelihood of refined product shortages the longer it persists. Such shortages increase the risk of price spikes, which in turn reduce end-user demand.

At present, I believe the contrarian move is to exercise caution amid what I view as heightened risk. This appears to me to be the best course. Investors should consider adopting a more defensive posture with at least a portion of their portfolio in the event that conditions deteriorate from here. They should be careful not to concentrate too heavily in stocks that require economic growth or low interest rates to support their prices. Defensive positioning can help mitigate the adverse financial and psychological impact of a prolonged energy crisis.

The Supply Deficit Is Larger Than the Headlines Suggest

Before the current disruption, the Strait of Hormuz carried approximately 20 million barrels per day of total petroleum liquids, equivalent to roughly 20% of global petroleum liquids consumption, according to the EIA. Real-time physical market tracking by commodities and shipping trackers puts the supply outage figure at 12.5 to 13.0 million barrels per day (bpd). I am using 12 million bpd as my anchor for this analysis.

Going country by country, the damage is severe. The key question relates to how much of the crude that cannot pass through the Strait has other outlets. From there, it is possible to estimate the net supply outages.

Saudi Arabia cannot export oil through the Strait, so it activated its East-West Pipeline, which carries a 7 million bpd nameplate capacity. However, the headline 7 million bpd figure overstates the amount that actually reaches the export market. Consider that approximately 1.5 million bpd of the 7 million bpd had already been flowing to feed two refineries that serve domestic Saudi consumption. Another 500,000 bpd of capacity is dedicated to LPG, a product stream with more limited uses as a refinery feedstock than crude oil. This implies a ceiling of incremental crude oil supply from the East-West pipeline of not 7 million bpd, but 5 million bpd. And the figure falls even further upon closer inspection. The East-West pipeline feeds the Yanbu Port on the Red Sea, where nominal loading capacity is 4.5 million bpd but tested capacity is closer to 4 million bpd. In wartime, throughput falls due to loading constraints. During wartime, Very Large Crude Carrier (VLCC) tankers loading crude at the Yanbu Port are required to sail during the day to avoid the hazards of nighttime travel and attacks by the Houthis. This travel constraint limits the number of vessels that can load crude at a given time, reducing export capacity from 4 million bpd to 3 to 3.5 million bpd. As a result, the headline of 7 million bpd of Saudi exports falls by half to 3.5 million bpd. Saudi Arabia is therefore capable of offsetting roughly 29% of the 12 million bpd of supply outages.

Iraq, the second-largest exporter through the Strait of Hormuz, has been devastated. Basra oil output has fallen by 76% to just 800,000 bpd from a pre-crisis level of 3.3 million bpd in exports. More production cuts are expected over the coming days if the Strait remains closed to Iraqi exports. The country declared force majeure on all foreign-operated fields on March 20 and is working to revive the Kirkuk-Ceyhan pipeline to Turkey, but the volumes are insignificant in the context of total Iraqi production losses. The pipeline is currently flowing approximately 250,000 bpd and will presumably reach full capacity of 500,000 bpd, at which point it will add 250,000 bpd of additional production, equivalent to 7% of Iraq’s total supply outages. Years of disrepair and underinvestment suggest the pipeline isn’t likely to achieve its 1.6 million bpd design capacity for several years. Certain Iraqi fields face the additional challenge that extended shutdowns increase the risk of geological and well damage. And to top it off, Iraq derives 90% of its government’s revenue from oil, so it faces a financial crisis on top of an energy crisis that will likely compound the supply disruption.

Kuwait is the most vulnerable Gulf producer. It has no bypass pipelines whatsoever. Every barrel of Kuwait’s 2.6 million bpd of production must transit Hormuz. The country has reportedly cut its production from 2.6 million bpd to just 500,000 bpd. The CEO of Kuwait Petroleum Corp. recently stated that it will take 3 to 4 months to fully restore the bulk of Kuwait’s production.

The UAE has the only other bypass pipeline outside Saudi Arabia. However, its ADCOP line from Habshan to Fujairah has only 440,000 bpd of spare capacity, a rounding error against the ongoing 12 million bpd supply deficit. Physical infrastructure damage at Fujairah and the Ruwais refinery, which was shut after a drone strike on March 10, further constrains even this limited workaround.

Altogether, Saudi Arabia, Kuwait, and the UAE have alternative pipeline capacity amounting to roughly 4 million bpd, representing one-third of the 12 million bpd of total supply outage. The remaining 8 million bpd must be sourced from Atlantic basin alternatives with 20-to-40-day sailing times. That represents roughly two-thirds of the total disruption with no near-term fix.

Recall that oil prices surged past $140 per barrel after Russia invaded Ukraine. At the time, the oil market expected the loss of 3 million bpd, which never actually materialized. Today, the market has been running an 8 million unresolved supply deficit for weeks. I find it amazing that Brent sits only slightly above $100 per barrel.

The SPR Is a Bandage, Not a Fix

Each successive SPR headline has had less market impact, and the math explains why. The entire coordinated global release of 400 million barrels across 32 nations amounts to roughly 4 days of global oil consumption. The U.S. contribution of 172 million barrels over 120 days implies a flow rate of 1.43 million bpd, covering just 12% of the approximately 12 million bpd that has been shut in. The U.S. SPR was at 415 million barrels before the release, roughly 58% to 60% of its 714-million-barrel capacity and not far above the 347-million-barrel historical low reached in 2023.

Note that by the fifth SPR announcement, oil prices didn’t react and then moved higher. The market has learned to discount SPR headlines because the volumes don’t move the needle against a disruption of this magnitude.

Crack Spreads Point to Physical Market Tightness

The refined product picture is also characterized by severe supply outages. The recent surge in crack spreads—the difference between the price of a refined product and the price of the crude used to produce it—puts them in reach of highs last seen after Russia invaded Ukraine.

Source: RBN Energy, March 26, 2026.

The gasoline crack is approximately $28 per barrel. The diesel crack has widened to $0.84 per gallon, 61% above 2024 levels. Jet fuel in Singapore has hit $227 per barrel. These margins provide refineries with a strong incentive to buy crude and run it. They imply that refining can remain profitable up to roughly $130 per barrel Brent. As long as that’s the case, crude demand from the refining sector stays firm even at elevated prices, which puts a floor under the physical market.

Refined Products: The Amplifier

The crude oil deficit is being compounded by a refined product squeeze that many investors fail to appreciate. On March 4, China banned all exports of gasoline, diesel, and aviation fuel via an order from the NDRC. Most of the world’s spare refining capacity resides in China. Its more than 19 million bpd of capacity versus its approximately 15 million bpd of refinery throughput, giving it significant excess production capacity and making its role in refined products analogous to Saudi Arabia’s role as the largest source of crude oil spare production capacity. By banning exports, China removed the single largest buffer for Asia-Pacific refined product supply. This has arguably been the most consequential policy decision of the crisis after the closure of the Strait itself.

After China’s move, South Korea has capped fuel exports, mandating that 90% of prior-year domestic volumes must be maintained before any exports are permitted.

Now, Australia is the canary in the coal mine. The days of remaining fuel supply have collapsed from 30 to 38 days before the crisis, to the point that more than 600 gas stations have run dry on at least one fuel type. In March, Australia imported 240,000 metric tons of U.S. fuel, the most in more than 30 years.

The situation is growing more acute elsewhere in Asia. Jet fuel in Singapore has surged to $227 per barrel from a pre-war baseline of $80 to $90 per barrel, while naphtha prices have jumped approximately 50% over the past month. VietJet has cancelled large-scale international routes, Air India has imposed surcharges, the Philippines has declared a state of national energy emergency, and Myanmar has imposed alternating driving days. These are not speculative outcomes. They are happening now.

The hoarding dynamic represents the tail risk that could push prices much higher. If more countries follow China and South Korea in restricting exports, or if the U.S. imposes any form of export restriction ahead of driving season, a 1970s-style panic-buying dynamic may take hold.

Timing Works Against a Quick Resolution

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