Not so Strait-Forward

Where are we at on the Middle-East war, and what it means for Oil

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TLDR - Key takeaways

• Physical oil market is far tighter than financial markets suggest

  Despite calm equity markets, flows through the Strait of Hormuz remain heavily disrupted and production shut-ins are still massive (~11.7 mb/d), implying a historically large supply shock.

• Prices are not reflecting physical tightness
  Equities are resilient, oil prices remain relatively subdued (~$100 Brent), and markets appear complacent versus fundamentals. Yet analysis suggests a possible $130+ structural range and spike risk toward $150+ if disruptions persist.

• Overall view: higher structural Brent floor ($75–80+), but volatile path with asymmetric upside risk in physical tightness.

  Recent correction and flattening of the curve makes me favour a mix of front and Dec 26 outright oil position
  Higher Brent floor also makes a continuing good case for owning oil majors

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INTRODUCTION
(Disclaimer: I’m a keen practitioner of dad jokes, so I hope you’ll forgive the pun in the title. And the slightly dramatic Avengers reference later in the article.)

Since Donald Trump (DJT) tweeted about a ceasefire with Iran on April 8, we’ve seen a sharp rally in U.S. equities and continued volatility in the oil market (trading within a wide range, but with a downward correction).

The casual observer might be led to believe that the situation is gradually stabilising.

Yet, flows through the Strait of Hormuz have not resumed. Just as importantly, if not more so, production shut-ins remain in full force, and with each passing week, the imbalance in global energy supply and demand deepens.

In this note, I aim to take stock of where we stand today and what the current physical oil market dynamics imply going forward.

GRAND ANNOUNCEMENTS FOLLOWED BY IRAN’S DENIALS
The U.S. administration has spent the past month actively jawboning markets.

We keep seeing headlines around talks led by Donald Trump and his administration, only for Iranian officials to quickly pour cold water on them.
A ceasefire was announced on April 8, but reports of violations from both sides followed almost immediately.
Meanwhile, messaging around the status of flows through the Strait of Hormuz has been inconsistent at best:

That leaves the average investor, or even the non-specialist professional, with the impression that the situation has improved dramatically. One can hardly be blamed for that view, given that U.S. equities are now trading above pre-war levels.

Yet vessel movements in the region remain very limited.
BCA Research, home to noted geopolitical analyst Marko Papic, recently put their Iran situation dashboard available for free.
As of today, it still shows highly constrained maritime activity. And with reports of the U.S. striking an Iranian vessel as I write, there is little reason to expect a meaningful recovery in flows in the near term:

So we still have a flow issue.

Then, just as importantly—if not more so for the medium term—we are facing a major production problem, which has only worsened since I last wrote about the topic on March 16.

At the time, we had estimated a little over 6 mb/d of production losses.

We have now plateaued at the expected peak of ~11.7 mb/d of supply disruptions since early April.

That is huge.
As a reminder, the largest prior supply disruption occurred during the Arab oil embargo of 1973–74, which amounted to roughly 7.5% of global demand at the time.
We are now closer to 20%...

This implies an ongoing loss of roughly 82 million barrels per week, or ~357 million barrels per month.
I’ve borrowed the chart below from JH (a terrific follow on Twitter) using data from Kpler:

On a cumulative basis, losses are now likely slightly above half a billion barrels at the time of writing:

Even if flows were to restart (and we are still waiting), it is important to consider the likely sequence of events following a full reopening:

• Vessels would first begin clearing the backlog (effectively acting as floating storage).

• They would then make their way to destination markets, typically 20–25 days to Asia, for example.

• After offloading, they would need to return through the Strait of Hormuz, which raises the first question mark. How will shipowners react, given that crews have already spent at least two months waiting under heightened security risks?

• Assuming they do return and begin loading new cargoes, this would add another 25–30 days.

A very rough calculation therefore suggests that production shut in due to storage constraints will take an additional 45–55 days from the restart of Hormuz traffic before normal loading can resume.

We could therefore see another ~0.5 billion barrels of lost production before returning to full capacity, and that assumes a smooth normalisation.
You can run your own scenarios, but personally, I remain sceptical that things will revert so easily.

Of course, the reality is more nuanced.
Production would likely come back gradually, making the exact volume of lost output difficult to estimate. If security conditions improve sufficiently, some vessels currently operating elsewhere could redeploy and partially offset the shortage caused by those stranded in the Gulf of Oman.

Even so, it is reasonable to expect several hundred million additional barrels of additional lost supply before shipping fully normalises.

As a reminder, in my February note on the bullish oil thesis, this was our baseline scenario:

Until conditions change, this is how the situation currently looks:

The above does not account for the duration of outages and is therefore, by construction, imprecise.
The objective is simply to highlight the order of magnitude and the scale of the current disruption (ie grey line on first chart vs blue line on the second chart).

In short, the physical situation remains very concerning.

HOW IS THE SYSTEM ADJUSTING ?
A month ago, in my article Unstable Equilibrium, I noted, based on calculations by Javier Blas, that roughly 5.5 mb/d of oil was being re-routed or added (notably from Iran) to offset the significant loss of flows through the Strait of Hormuz.

Assuming this figure has remained broadly stable, the system would still be short between ~5.5 and 9.5 mb/d.

At the time, the International Energy Agency had just announced a coordinated release of ~400 million barrels.

Since then, the U.S. Energy Information Administration has estimated that in April:

• roughly 7 mb/d was drawn from inventories (significantly more than initially expected),

• around 2.3 mb/d was offset through demand destruction, primarily in Asia.

This broadly aligns with assumptions from JPMorgan in the following note:

• They estimate that refinery runs were reduced by around ~2 mb/d (i.e. demand destruction). This is lower than initially expected, but largely offset by the following:

• Aggressive inventory draws, amounting to roughly ~6.6 mb/d
  

As they note, OECD commercial crude inventories could fall toward operational minimum levels by early May.

Following the “crude shock deadline” in mid-April (i.e. the point at which the last cargoes that transited the Strait of Hormuz before the blockade reached their destinations), the physical market now appears to be entering a new phase, potentially characterised by more pronounced demand destruction.

For those still operating, namely refineries, we may be approaching a pricing environment where buyers are effectively “paying any price” to secure cargoes.

This dynamic is highlighted in a recent note by HFI Research on 20th of April.

Is the Futures market reflecting this ?

WHAT HAS THE PRICE RESPONSE BEEN ?
As I alluded to earlier in the article, markets appear significantly less concerned than the physical situation would suggest.

If we look at the price movements of a few asset classes since the start of the war:

First, the S&P 500 is up since then.
Quite baffling.

Energy equities are down, but this masks an important point: they remain the best-performing sector year-to-date, up roughly 25% since the start of the year (i.e. they had already rallied strongly ahead of the war).

Now, this chart does not really indicate whether oil is fairly priced.

Given the scale of demand destruction, I noted in my previous article that we would likely need at least $110–$130 per barrel of Brent crude oil over an average of six months to rebalance the market.

We are clearly far from that.

• March averaged $98/bbl

• April is so far averaging $99/bbl

Meanwhile, Dated Brent (used for physical settlement) has been pricing higher, but still dipped below $100/bbl during the week of April 13.

If you recall the monthly WTI price chart I shared in February to highlight the attractive risk/reward of being long into 2026, we have since moved higher. I have now replicated the same framework using Brent front-month futures, which gives the following picture:

In red, the last two months of pricing are shown. Given the scale of the chart, they are barely visible, but we closed March at $103.7/bbl and are now at $101.4/bbl.

Given the current scale of disruptions, I would not be surprised to see brief spikes above $150/bbl. More structurally, the market could enter a $130+/bbl monthly average range for several months, as shown above.

That said, this will depend on, and continuously interact with, the evolution of demand destruction, which needs to be monitored closely.
Unless demand destruction accelerates significantly before price move up materially higher, a price spike is almost like Thanos in the Avengers’ movie …

(NB: my only mantra in trading/investing is never say never, so to be clear, the above is for dramatic effect only !)

Countries in Asia felt the impact first.

We then witnessed similar signals from European national regulators such as Italy toward airlines.

So the real economy is already being impacted.

Eventually, the U.S. would also be impacted given the tight global interconnections. For example, the largest stock by market cap, Nvidia, relies heavily on outsourced chip manufacturing in Taiwan, which has limited energy storage capacity and has already discussed potential industrial rolling blackouts if tensions in the Middle East were to persist.
However, the U.S. remains in a relatively strong position as a net energy exporter.
I will not attempt to predict or advise on U.S. equity indices, other than to note that I remain part of the (seemingly large) group of investors surprised by the complacency in equity markets.

Rather, I will focus on what this implies for commodities more broadly.

WHAT DOES THIS MEAN FOR POSITIONING ?
In my first oil note, I described what I saw as an attractive risk/reward setup.

At the time, my exposure was broadly split as follows:

• ~1/3 in oil equities

• ~1/3 in deferred crude futures (Dec 26 and Dec 27)

• ~1/3 in long optionality across various strikes, mainly Dec 26 maturities

Following the escalation and partial blockage of the Strait of Hormuz, front-end implied volatility in oil became prohibitively expensive to hold. At the same time, extreme backwardation¹ made exposure to the front of the curve less attractive.

I rolled part of the optionality further out and slightly higher, but initially maintained most exposure in Dec 26 maturities.

More recently, I feel the curve has become less complacent, as has the flat price².
As a result, I believe it is now more attractive again to allocate closer to the front end of the curve.

I have maintained my exposure to oil equities. One clear implication of the current environment is that, regardless of any meaningful resolution of the conflict, we are likely to see a higher structural floor in Brent prices going forward, which is supportive for oil majors.

Security risk in the region will also now be priced through a different lens.

Previously, I suggested that $70–75/bbl would represent a new floor for Brent crude oil. Over time, that range now looks too low. We are increasingly moving toward a $75–80/bbl floor, or potentially higher.

As a result, I also continue to favour adding exposure further out on the curve, particularly within the next six months, where I believe prices remain attractive relative to this evolving floor. Beyond that horizon, demand destruction could temporarily weigh on prices depending on how high we move in the interim.

Finally, the curve has flattened significantly, as illustrated by the narrowing price spread between June 2026 and December 2026 Brent futures:

I have therefore started to rebuild upside exposure on the nearer part of the curve.

This is primarily being done via risk reversals³, in order to either remain roughly flat on the trade or, if exercised on the put leg, be effectively long at what I consider to be the “new floor” for Brent crude oil going forward, as described above.

I am also mindful of the broader impact on the global economy.
First on my equity allocation.
But similarly on commodities: they are directly exposed to physical constraints and second-order macro effects.
As a result, I remain relatively defensive.
This explains why I have maintained a less aggressive long bias in industrial metals, which I still fundamentally like over the medium term.

I have also attempted a long position in sugar, which could potentially benefit from higher energy prices, as farmers make planting decisions in April, particularly in Brazil. However, after an initial spike, prices have since retraced sharply. I still hold exposure via call options on next season, but the trade has so far been disappointing.

Finally, I remain overweight grains. This is primarily driven by historical price levels rather than the war itself. However, as noted in recent analysis, bottlenecks in fertiliser inputs (particularly urea and sulphur) could impact yields in the upcoming season and support higher prices.

CONCLUSION
Does the market knows better and is pricing more accurately a physical resolution ?
In my experience, and Covid showed it, the market can be wrong. A clearly dire situation can stare at us in the face and yet the market takes time to price it.
At least that was my feeling during January 2020 and sticking with the process was the right thing to do.
Therefore I am holding my defensive positioning for now, at the risk of missing some market adjustments.

The English proverb “better safe than sorry” really comes to mind now.

This is clearly not trading recommendation or financial advice.
We all have different risk sensitivity and investment targets and horizons.

However, what remains clear is that the physical reality in energy markets today is increasingly disconnected from financial pricing across multiple asset classes.

This is opportunity.

As we began to understand during Donald Trump’s return to the White House, it increasingly feels like we are operating in a new regime of:“Make Macro Great Again.”

As always, remember the DYODD

Do Your Own Due Dilligence !

Thanks for reading,

Fred

1. Backwardation is when the price of a commodity for immediate delivery is higher than for future delivery. It tends to happen in a bullish market setup. The opposite situation is called Contango.

2. Flat price is the outright price of the commodity, the headline price you see in the news (e.g. $80/bbl oil), not the differences between contracts or months.

3. A risk reversal is an options strategy where you combine a call option and a put option on the same asset, but in opposite directions, usually to express a view with little or no upfront cost. If one is bullish on crude oil for instance he or she could buy a call option and sell a put option with a similar premium to have a zero cost structure.