Red Sea Crisis Leaves Oil Market Cold. But This May Change

Last week, Brent crude closed above $81 per barrel, close to $82. This was a solid increase from the start of the week when the international benchmark was trading at around $78 per barrel. Yet these prices are about the same as prices were when the Yemeni Houthis began attacking ships in the Red Sea.

The seemingly unnatural price movement probably played a part in Saudi Arabia’s decision to stop working on expanding its production capacity and contributed to already rife uncertainty about the long-term future of the oil industry in investment circles. It also made oil traders complacent. And complacency is dangerous. Because the situation is quite dynamic, and there are already warnings that it can change quickly.

When the Houthis struck their first ship in early November, oil prices actually went down—from over $90 per barrel of Brent in late October, the price was some $77 per barrel by early December. Nobody worried about supply disruption in the Red Sea because the Houthis were not targeting oil tankers.

Where it gets more interesting is that even when they did attack an oil tanker—a fuel vessel for Trafigura—prices did not tick up. Benchmarks remained stubbornly range-bound. The dominant sentiment in oil markets was that supply was sufficient. In fact, a feeling was settling that there is an oversupply of oil.

There were some pretty good reasons for that feeling. For starters, fears of an escalation of the Israel-Hamas war have subsided amid talks about a ceasefire. The lower the risk of escalation, the thinking goes, the lower the risk of oil supply disruption.

Then there is the spare capacity argument: ING analysts reminded the market about it last week when they wrote that OPEC has some 5 million bpd in spare production capacity. Of this, 3 million bpd was in Saudi Arabia. Traders appear to assume that should supply be disrupted in the Middle East, the Saudis will step in to help—which they might not do, if recent history is any indication.

Back in 2022, when sanctions potentially threatened several million barrels of Russian oil and fuels, prices surged into three-digit territory. In the summer of that year, worried about rising retail gasoline prices, President Biden asked the Saudis to boost production. The Saudis responded with the equivalent of “We’ll see” and then did nothing.

Chances are this will repeat should prices surge once again, for whatever reason. The reason it will repeat is that the Saudis have been trying for months now to push prices higher, to no avail. The market simply refuses to acknowledge the possibility of demand outpacing supply, and this is thanks to forecasts like the International Energy Agency’s monthly oil market report, which often underestimates demand trends.

For this year, for instance, the IEA has so far forecasted an oil demand growth of 1.2 million barrels daily while supply, according to its estimates, should expand by 1.5 million barrels daily. However, the estimates have failed to incorporate the effect of the Red Sea crisis on oil demand, which has been notable—and quite literal.

Rerouting vessels from the Suez Canal to the Cape of Good Hope adds over a week to journeys between Asia and Europe. The overwhelming majority of these vessels are powered by petroleum fuel. The rerouting directly increases oil demand—by around 200,000 bpd so far, according to an unnamed source who spoke to Reuters commentators George Hay and Yawen Chen.

This means, then, that in a best-case scenario, oil demand this year will grow by 1.4 million bpd rather than 1.2 million bpd—and possibly much higher. And there is never certainty about non-OPEC supply, either. Usually, supply forecasts focus on U.S. production growth, but this year, the U.S. Energy Information Administration said it expected a sharp slowdown in production growth. In fairness, very much like the IEA, the EIA has been wrong before, but it still pays to keep an eye on the pessimistic scenarios for the immediate future as well.

Meanwhile, earlier this month, Standard Chartered warned that global oil supply may be much tighter than previously believed, and the market could swing into a deficit as soon as this month, to the tune of 1.6 million bpd. It’s not the only one, either. The EIA also expects an oil supply deficit for February, and a larger one than StanChart, at 2.3 million bpd.

The balancing factor for prices, somewhat ironically, is the fallout of the Red Sea crisis itself. Because of longer journeys, trade between Asia and Europe has become costlier, impeding business activity expansion and, as a consequence, putting a lid on oil prices. For now, this is working for oil traders, who appear to be more focused on economic updates rather than news from the oil industry, thanks to the increase in algorithmic trading.

Most analysts still warn about the potential for escalation in the Middle East. The risk is there but has not yet manifested itself, which is why oil prices are where they are. Nobody seems to be really interested in further escalation. And that’s really good news for oil consumers.