It's been five months since the U.S. got drawn into the Iran conflict, and despite almost weekly “TACOs”, there's still no end in sight. Yet oil prices fall, and the S&P 500, Nasdaq, and Dow Jones rise every time headlines suggest the sides are returning to the negotiating table, as they did this Monday. Why?
In part, because of inventories.
Before the conflict, the market had a cushion. The IEA expected a production surplus in 2026, with around 8.2 billion barrels in storage, and China had spent months stockpiling crude. So when flows through the Strait of Hormuz dropped from about 20 million barrels a day to just 2.7 million barrels a day between March and May, that cushion helped avoid an immediate supply shock. China cut imports, Atlantic producers increased exports, and Saudi Arabia and the UAE rerouted part of their shipments outside the Strait.
But that cushion is running out: OECD public reserves are at their lowest since 1990, while the U.S. Strategic Petroleum Reserve is at its lowest level since 1983. On top of that, part of the oil stored in the U.S. cannot reach the market quickly because of infrastructure bottlenecks. The IEA estimates the market could face a deficit of nearly 900 million barrels by September.
Rebuilding those reserves would require adding around 1 million barrels a day for three years. So even if the conflict in the Middle East ends, energy prices could remain high, which is why major central banks remain hawkish.
At the Fed, three members voted for a rate hike, while markets price in more than a 60% chance of a rate hike in September. At the Bank of England, three out of nine members also backed a hike, while the Bank of Japan warned that persistent inflation risks could require further tightening. The ECB also noted that the full impact of the energy shock on inflation has yet to be reflected and will continue monitoring its duration, scale, and spillover effects on the economy.
Thus, the longer this back-and-forth over Iran talks continues, the worse it could become for the global economy and, in theory, markets.
As for this week, Iran said it does not plan to send or receive a delegation for talks with the U.S. "in these days." If that holds, optimism could fade again, bringing back volatility to oil, even as OPEC+ agreed to raise production quotas next month.