Why We Haven’t Seen Oil Prices Spike

$280 per barrel.

That’s how high oil prices would get if Iran’s blockade of the Strait of Hormuz yielded the same price action we saw back during the 1973 oil crisis.

If you’re reading Moneyball Economics today, you can almost certainly remember the impact of OPEC’s oil embargo back then. Constant lines at the pump. Constant pressure on your wallet. Oil prices quadrupled and ultimately wreaked havoc on millions of everyday Americans.

But the 1973 oil crisis only took an estimated 6-9% of oil out of circulation worldwide. Iran’s blockading a strait that handles 20% of all worldwide oil traffic. So you think the impact on the economy would be even greater.

Why aren’t prices rising faster?

The answer to that question might be more concerning than you expect.

Click the video below for the full story:

Video transcript:

Welcome to Moneyball Economics.

I’m Andrew Zatlin, and today I want to ask and answer the question — why haven’t oil prices gone up a lot higher?

Because let’s face it, prior to the war with Iran, 20% of the world’s oil was flowing through the strait of a Hormuz and suddenly it’s offline.

You take 20% of the world’s oil offline so suddenly you would expect prices to triple, quadruple, wouldn’t you? I mean, that’s what happened when the original oil shock took place in 1973. Prices per barrel quadrupled. You go back to 1980, ‘81 when we had the original Iran-Iraq war, same thing. Oil was not supplied via the Straits of Hormuz and the prices doubled and even tripled.

Today, the price of oil’s up maybe 20% since before the war. Have we totally taken the laws of supply and demand and thrown them out the window? Or are there other things happening?

Well, it turns out that the laws of supply and demand are very much in place. There are some near-term adjustments that have been made to mitigate this situation. At the same time, there are deeper structural things underway and a very dirty secret of China’s has been exposed, one which has a lot of downstream implications going forward.

Let’s start off with why I say the laws of supply and demand are firmly in place — when 20% of the world’s oil supply disappears, but the prices don’t budge that much.

Well, it turns out that 20% of the world’s oil supplies didn’t disappear. Yes, ships aren’t flowing back and forth across the strait, but that isn’t the only way that oil can flow. Turns out there are a lot of pipelines that can move oil over land, and suddenly all that capacity has been ramped up and has been open.

On a good day, about 16 million barrels per day were flowing through the straits. 20 million at the peak, but 16 million on average. So you take that 16 million barrel per day shortfall. Well, Saudi Arabia’s discovered about six or seven million barrels per day capacity through their pipeline. Boom. UAE, Kuwait, same thing. They can pipe it over land through pipelines.

Boom. We’re looking at a shortfall actually of maybe five million barrels per day.

So it’s not as staggering, still significant, but not as crisis. Now, offsetting that five million supply shortage, we’ve got strategic reserves in the United States. We’ve got strategic reserves in China. So the government is able to release into the marketplace enough oil to make up for the shortfall.

And guess what? You also have the private sector pumping away because 85 bucks a barrel, it’s still plenty of good profit for all the companies out there.

So that’s why the supply shock is not really as big a supply shock for now.

Obviously, these reserves don’t last forever.

They last maybe another six months.

But for now, life is okay. At the same time, it turns out demand for oil today is a lot more elastic than it used to be. I mean, back in ‘73, back in ‘81, demand was demand. It wouldn’t change over time. And so that created that upward pressure on prices. Today, well, there is demand destruction. People can, for example, opt to stay at home rather than commute into work. So as a result, oil consumption has come down.

And speaking of oil consumption, that’s where things get even more interesting. China was able to reduce their oil imports by 40% in June, and they are the world’s largest importer of oil. They were able to reduce millions of barrels per day.

Well, they were forced to as well, but they were able to do that because they made a strategic decision.

It was too expensive to import oil at 85 bucks a barrel when they had cheap oil that they’ve been buying from Russia and Iran in their reserves. They have a two billion barrel capacity reserves. And this, my friends, is where the dirty secret comes in.

So recently, someone did the math at the EIA, the Energy Information Association. It’s the independent formal body out there that tracks oil consumption globally. And they came out with an interesting report recently that said, “Holy cow, it looks like oil demand around the world is actually dropping, dropping substantially dropping one million barrels per day. We are now consuming oil at a level we haven’t seen since 2020 when COVID was raging and the economies of the world were slowing down.

“What’s behind this drop in oil consumption?” They say. Well, it’s a combination of things…

There is more efficiency with oil consumption. We’ve got EVs out there which continue to reduce demand for oil and so on and so forth. But there’s something else going on here, and it goes back to this two billion barrel reserve that China has created. China filled that. And you know how they filled that? Well, by importing.

Turns out when I do back of the envelope math, the past three to five years of oil production and consumption has been dominated not just by China imports and consumption, but by their stockpiling. And guess what? They’re done stockpiling. They don’t need to continue to fill the reserves. They have filled them. What this means is that estimate of one million barrels per day is probably light.

We’re going to see an even bigger drop because China is going to stop buying oil for their reserves.

They’ve topped it off. Maybe they’re going to draw some of it down, but by and large, oil demand until now has been a myth. It’s been overstated by this Chinese demand. What that means is going forward, we can expect a million barrels per day of a drop to turn into one and a half to two million barrels a day dropping.

That’s substantial. That is exactly what you need in a demand supply type of environment to push prices back down. It also indicates that going forward, Iran has a lot less leverage. China’s going to be a lot less dependent on Iranian oils if the amount of oil that they actually need actually consume on a daily basis is a lot lower than what they’ve been buying.

So let’s see what happens with Iran. I don’t think Iran’s leverage is growing. I think it’s shrinking. And I think that oil is going to get even cheaper.

And for oil producers around the world who depend substantially on oil for their revenues like Saudi Arabia and UAE, this is not a good thing. But for people who rely on oil to drive cheap energy like the United States and China, it is a good thing.

A lot of doors are opening and some doors are closing. Let’s keep on top of this. We’re in it to win it folks.

Zatlin out.