Oil industry showed remarkable resilience when faced with the biggest?energy shock in modern times, pulling many levers to soften the blow from the Iran War. The global market could be months away from breaking point if there is no breakthrough in peace talks. Since the start of the Iran War and the 'near-hermetic closing of the Strait of Hormuz, the world's largest and most liquid commodities market has been in a state of unprecedented uncertainty. The Strait of Hormuz was previously the conduit of a fifth of global oil and gas supply. Few experts predicted that Iran would shut down the Strait before the conflict started on February 28. No one expected the blockade to last for months.

With peace efforts failing and the threat of a new military escalation high, the markets cannot ignore the possibility that the transit through Hormuz may remain restricted for many weeks.

The clock is ticking. Oil market has approximately three months left before the tightening of supplies begins to take effect. This will push inventories down to critical levels, which will lead to sharper price increases and, ultimately, demand destruction.

MUDDLING THROUGH So far, the industry's response has been remarkably effective. This crisis was a historic one, with a loss of approximately 13 million barrels of oil per day. Import-dependent countries, especially in Asia, acted quickly to secure alternate sources of supply, mainly in the U.S. The International Energy Agency (IEA) coordinated the release of 400 million barrels from member state strategic reserves. The cost of absorbing this shock is still high. As refiners reduce production, airlines trim their schedules and government implements fuel-saving measures, the demand is already declining. According to the IEA,?global demand for oil will decline by 2.4m barrels per daily (bpd), or about 2.3% from a year ago in the second quarter.

These adjustments were accompanied by an immediate drawdown of inventories, which is the primary shock absorber for the system. U.S. Energy Information Administration data revealed that global crude oil and fuel inventories fell at a rate of 5.27 millions bpd during March. This increased to 8.62million bpd by April.

According to the IEA, draws are expected to peak around 9 million bpd during May before?slowing down to 2.7 millions bpd between September and October. At that time, inventories will begin to rebuild.

These projections are based on an important assumption: the Strait of Hormuz will reopen by late May, and traffic will resume in June. This timetable looks incredibly optimistic, and suggests that stock draws could be deeper and last longer than official estimates suggest. In fact, independent analyst Paul Horsnell, a veteran, estimates a steeper rate of depletion. He estimates 7.4 million barrels per day in March, 10.8 in April, and 10.2 in May, with 11.2 in June. This would be a loss of 1.2 billion barrels in global inventories.

Horsnell says that at this rate, commercial inventories may fall below the minimum operating level - the thresholds where storage systems cannot function efficiently – as early as August.

SYSTEMIC -BREAKDOWN History shows that markets rarely reach these hard limits. Participants tend to adjust quickly and efficiently in order to avoid a systemic breakdown. This has been demonstrated over the last few months. There are a few important caveats.

One, the timeline of the Strait of Hormuz reopening remains uncertain. Any partial resumption of flow could materially reduce the pressure on global supply. Technical constraints on storage systems will not be met everywhere at once. Shortages are more likely to occur unevenly, sporadically and not in a global "crisis".

Prices are also a powerful "counterbalance" mechanism. Oil prices are historically negatively correlated to observable inventories, increasing as stocks fall. The price of oil would likely rise if the depletion continued, which in turn would reduce consumption and ease some of this strain. Brent crude futures, the global benchmark, have risen by about 50% since the beginning of the?war to $110 per barrel. However, given the size of the crisis they have much more room to grow.

China is another important factor. Beijing has the world's largest stockpile of oil, estimated to be around 1.2 billion barrels. It could offer additional relief by reducing inventories and reducing imports. The market has some buffers left. They are limited and consumed quickly. The global energy system is increasingly stressed with each day that passes of restricted flows through Hormuz. It may be a while before the breaking point is reached, but thanks to a combination?of policy choices, price reactions and geopolitical development -- it's getting closer. If it does ever arrive, the impact will be huge.

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(source: Reuters)