Just a few months ago, oil prices were surging and there were forecasts it could get worse.
But, defying forecasts of doom, oil prices are crashing to levels seen at the start of the war. The Economist predicted $150 oil, now they admit they were wrong. Yet, closing Hormuz was a bigger oil supply shock than previous oil crisis. Hormuz was effectively closed for longer than expected – over 100 days, and even now, oil flows are nothing like the previous levels, with reports of ongoing skirmishes. So why are prices not higher? In theory, the loss of Hormuz, should have led to shortfall of at least 8-10 million barrels a day.
Well there are several reasons, some good, but some quite worrying. Perhaps the biggest reason for oil prices being lower than expected is simply that China dramatically cut back import demand a fall of at least 33%. Seaborne imports fell even further 6.4 million barrels per day in June. Rather than buy with rising prices, China simply drew down on their impressive 1.4 billion barrels of oil, and even now, seem slow to buy oil to replenish their stocks. It wasn’t just China, the US and IEA launched their biggest drawdown from inventories on record.
The US strategic reserve has reached a multi-year low. But China is by far the biggest importer of oil from the gulf, and it seems they were ready for such an incident. Ironically, as we shall see, China’s deft strategic reserve policy has done a huge favour to European and US economies.
Global Oil Demand
The second reason for lower oil prices speaks to a longer-term trend, the Hormuz crisis only accelerated. Global demand for oil is plateauing at the same time as a supply glut. In the 1970s, oil was all pervasive with few substitutes, but today, oil intensity has fallen from 6% of consumer spending in 1980 to 2% in 2025. The truth is, the future is no longer crude oil; the future is electric. China is leading the way with electric lorries, which can be recharged in the same time as it takes to fill up diesel. Diesel is actually the most profitable part of refining crude oil. A long-term fall in diesel demand is bad news for the profitability of crude. It is only a matter of time, as electric cars and lorries take a growing share of the market. And the Iran crisis was a timely reminder of the desirability of switching to electric. And the technology of batteries continues to improve at just at the right time. There is a global boom in battery capacity. Battery combined with solar is providing near 24 hour electric capacity in places like California. It’s not all clean energy. In Asian countries like Malaysia and India, oil products were used in cooking, heating as well as transport. Here the oil crisis was very real, with actual shortages and consumers priced out. But there was a surprising adaptability with consumers simply switching to coal, wood. The Iran crisis may well prove to the last hurrah for coal
Recession Risk
But, whilst these long-term trends of rising renewables and falling fossil fuels is a positive development, it would be a mistake to underplay the continued importance of oil. China’s reserve may have prevented a spike in oil above $120, but it doesn’t explain the drop to $70 day. This fall is due to weakening demand.
The US job market continues to be weak, with a fall in participation rates often a precursor to rising unemployment. Outside the health care sector, job creation is the weakest for years. There are signs of falling demand for heavy truck sales. A slower economy means less demand for oil. I would be wary about predictions of US recession, in that the US economy frequently brushes off forecasts of doom, but certainly consumers are pessimistic about the state of finances, unsurprising given the burst of inflation had led to negative real wage growth. Also, the rise in inflation, increased interest rates expectations, which would weigh heavy on a US economy with growing levels of debt. And whilst stocks may be soaring US savings are near record lows.
Supply
So if demand is weakening, there is also another story about supply. Before the war started the EIA reported a supply glut of 1.5 million barrels, this glut was a persistent story in oil markets, driving prices down.
Of course, the war did flip this glut into a shortage as Iran has played its card of blocking Hormuz, but in the long-term, this threat of blocking Hormuz will have much less leverage. This is why oil is still flowing from the Gulf — through overland pipelines that bypass Hormuz entirely, like Saudi Arabia’s East–West line and the UAE’s pipeline to Fujairah. And the UAE is building more. The Gulf States who dislike the Iranian regime will never want to rely on Iran again. The problem is that what kind of oil market will they face? US shale oil has transformed the market. But it’s not just the US, Countries like Guyana, Venezuela and Canada have all responded to the higher price signal by supplying more, Brazil managed a 20% increase in oil supply becoming an important substitute for gulf oil. Not all oil is the same; Venezuelan oil is heavy and poor substitute for Gulf oil, there is still a large spread between oil and oil products like Jet Fuel. Yet, at the same time, refineries are becoming better and more flexible to produce higher yield products like jet fuel and diesel.
Bloomberg also point out that in the past, people hedged against rising oil prices by buying oil futures. This created a self-fulfilling prophecy that when people feared rising prices, future prices would soar. But now you can insure yourself against rising oil prices without buying oil futures. Call options enable insurance without pushing up prices. It is striking how short-lived oil price rises of 2008 and 2022 actually were. Oil prices were very volatile, now less so. In theory, you would expect oil prices to be slower to fall, especially given the US and China and other countries will be wanting to restock inventories.
So who are the winners and losers from this collapse in oil prices? Well, the fall in oil prices is a real boon to western economies like the UK which are net importers of oil products. The Iran War caused a decline in living standards at a time, when households were fed up with stagnant living standards. For the new prospective PM, Andy Burnham, the dramatic fall in diesel prices is probably his best hope of delivering on cheaper cost of living. It also gives a breather to monetary policy. UK mortgage rates shot up on expectations of higher inflation and higher interest rates, the fact that inflation may remain lower than feared means it is quite possible these mortgage rates will come back down.
Winners and Losers
The big losers are potentially, oil producers, if an oil shock can’t lead to higher prices, it does raise the question are we really reaching peak oil? Before the crisis, oil prices were in long-term decline, there was just too much supply with demand stagnating. The Iran War has only increased the incentive to transform oil based economies. But, for countries which base their economy on oil — Venezuela, Russia, the Gulf states — the long-term outlook may mean weak export and tax income. The war was supposed to prove oil’s power; instead it proved its decline.
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