The oil markets have been far more sanguine about the conflict in Iran than analysts. It took weeks for the markets to price oil at $100- and it hasn't venture very far beyond that.
The markets initially reckoned the conflict would end in four to six weeks. They have been proved wrong. What is even more baffling is that the markets seem relatively unruffled even today, some 11 weeks into the conflict.
Analysts think that if the conflict lasts for another two or three weeks, oil prices will go through the roof. The futures markets don't reflect this.
We should know soon who is right.
My column in BS, Oil markets wrong on Iran?
Oil
markets wrong on Iran?
Despite
the biggest oil supply disruption in history, markets remain slow to react
T T RAM
MOHAN
There is
one great mystery in the Iran conflict: The behaviour of the oil markets. This
is said to be the largest disruption in the history of oil markets. Yet the
markets have been pricing oil at levels well below what analysts believe the
fundamentals warrant. Either the analysts are fools. Or the markets have been
hopelessly myopic. We should know in the weeks ahead.
After the
Iran conflict erupted in late February, oil prices stayed well below $100 in
the initial days. Experts concluded that the conflict would not last more than
four to six weeks. The disruption to the world economy would not be
considerable.
The notion
that the disruption in oil supplies would cease immediately if the conflict
stopped within four weeks or so was absurd. As The Economist (April 30) points
out, production at oil wells cannot be switched on in a trice — it takes
several weeks for production to return to normal. Tankers that have switched to
other routes have to return to the Persian Gulf, again a time-consuming
process. Refineries that were out of action for want of crude oil supplies have
to be restarted. The disruption in oil supplies was bound to stretch well
beyond any cessation of the conflict.
The oil
markets — and the experts who relied on them — were proved wrong. The conflict did
not end in four to six weeks. It has stretched to over 10 weeks and is still
on. The worry is whether the oil markets are reflecting the Iran situation
adequately even now. Analysts do not think so.
The oil
markets’ big failure was not anticipating Iran’s ability and willingness to
close the Strait of Hormuz. They seem to have assumed that because this had not
happened in the past, it would not happen now. Iran’s leaders had issued very
explicit warnings about how the country would retaliate to an American attack.
These warnings were not taken seriously by the United States administration or
the oil markets.
The
Economist estimates that the closure of the Strait of Hormuz in the last two
months has taken out supply equivalent to10 per cent of global consumption over
the last two months. Oil prices have been slow to react to a shortfall of this
magnitude. In the past, smaller shortfalls in supply had caused much larger
increases in oil prices.
It took
nearly three weeks from the outbreak of the conflict for oil prices (Brent
crude) to touch $100 per barrel. At the time of writing, it is $112 per barrel.
This is the price of a three-month futures contract for July 2026. Thereafter,
the market sees the oil price dropping to $104, $99 and $95 in August,
September and October respectively.
What do
the oil markets know that analysts don’t? The current oil prices are difficult
to square with the supply-demand balance in the oil market. Still less do they
square with the status of the conflict between Iran and the US-Israel alliance.
Analysts believe that President Donald Trump’s upbeat messaging on the course
of the conflict — “we are close to a resolution”, “it will end soon”, and such
like — has had much greater effect on the oil markets than is warranted.
If the analysts are right, the world economy could soon be in serious
trouble.
Even at levels
the oil prices have seen thus far, the impact on the world economy will be
significant. The International Monetary Fund’s World Economic Outlook (April
2026) assumes an average petroleum spot price of $82 per barrel for 2026 in what
it calls its “reference” forecast. In this scenario, global growth falls to 3.1
per cent in 2026, from 3.4 per cent in 2024. That is 0.2 percentage points
below the IMF’s January forecast before the Iran conflict broke out. This fall
does not capture the full magnitude of the impact of the Iran conflict. But for
the Iran conflict, the IMF reckons, global growth would have been 3.4 per cent
or the same as last year.
How
realistic is the assumption of an average price of $82 per barrel of oil for
2026 as matters stand today? In the first four months of this year, Brent crude
has averaged $87. Most analysts believe that if the Strait of Hormuz remains
closed for another four weeks, oil prices will shoot up to well above $125,
perhaps even touch $150 per barrel.
If that
happens, the prospects for the world economy are truly dire. If oil prices
average $100 per barrel, the IMF estimates global growth to drop sharply to 2.5
per cent. At a price of $110 per barrel, growth will drop to 2 per cent, which
is close to global recession.
Despite
the conflict, US growth in the reference forecast would be 2.3 per cent in
2026, higher than the 2.1 per cent in 2025. While the world languishes, the US
remains relatively unaffected. This may explain its appetite for the conflict
in the first place. But it’s not as if the US has not been impacted by the Iran
war. Before the war broke out, US growth in 2026 was projected at upwards of
2.5 per cent.
There is
an important fact that has got obscured in the revised growth forecasts consequent
to the Iran war. The war has impacted the world economy in a way in which Trump
tariffs had not. Economists had warned of the folly of US tariffs and the grave
consequences that would follow. They have ended up looking foolish.
Three
points are worth highlighting. First, world economic growth was unscathed by
the Trump tariffs in 2025 and it was poised to remain unscathed in 2026.
Secondly, US growth in 2026, following the tariffs, is projected to be higher
than in 2025.
Most
dramatically, world trade growth grew by a phenomenal 5.1 per cent in 2025, up
from 3.7 per cent in 2024. Expansion in technology-related exports offset
slower growth in other categories. China reoriented its exports from the US to
Asia and Europe and recorded a new high in goods trade surplus of $1.2
trillion.
President
Trump’s instincts about tariffs have been proved right —they benefited the US
economy without harming the world economy. What a pity his instincts have let
him down on Iran.
