Oil Prices Return to Pre-War Levels as US and Iran Reach Agreement Framework

In a significant development for global energy markets, oil prices have declined to pre-war levels following the agreement between the United States and Iran to negotiate within a framework that includes reopening the Strait of Hormuz. With oil flows from the Middle East beginning to return to the market, analysts, investment banks, and traders anticipate a global oil surplus could return as early as 2027, further pushing down oil prices. Many analysts suggest prices are heading toward the $60 per barrel mark.

The futures market reflects similar sentiment. Speculators are betting on where they believe prices will head in the short term, and over the past month, the majority have become bearish. The resumption of oil flow through the Strait of Hormuz is leading traders to believe that the shortage and supply disruptions have ended.

No Formal Agreement Yet

However, most bets and oil price forecasts assume that the Memorandum of Understanding (MoU) between the US and Iran represents a genuine and sustainable peace agreement. This is far from the truth—it is merely a framework for negotiating a potential agreement by the end of August. Progress on this front shows no signs, at least publicly, and the situation could deteriorate at any moment with increasing tensions.

Iran has not abandoned its claim to some form of permanent control over the passage through the Strait of Hormuz, including demanding "toll fees" for safe passage through this critical chokepoint, in coordination with Iranian authorities. Meanwhile, traffic through the strait is recovering slowly, but shipowners and operators remain cautious in their approach to voyages and the terms applied.

Washington's Plan to Counter Iran's Hormuz Advantage

Keeping oil prices low, particularly ahead of the US midterm elections, may be sufficient motivation for the US government to push for an agreement. However, this will not be easy, and concessions will likely have to be made. Furthermore, Iran's nuclear program remains unresolved in both the MoU and in the limited negotiations that the parties have held since they agreed to reach an agreement in mid-June.

Most market speculators are betting on Hormuz volumes recovering in the third quarter and oil prices declining by year-end. Traders point to how the market has best handled the worst supply disruption in history. However, this is due to many factors that have largely cushioned the blow.

Depleted Oil Reserves

Conflict and the halt in flows through the Strait of Hormuz have depleted oil inventories everywhere except China's massive reserves, leaving no buffer outside China to compensate for another disruption. Rebuilding reserves will take time and money, and will partially support future demand.

The upcoming global race to rebuild depleted oil reserves won't be enough to offset a massive surplus expected to hit the market next year, as flows through the Strait of Hormuz appear to be normalizing, Goldman Sachs noted last week.

According to Citigroup, Brent crude oil prices could fall to as low as $60 per barrel by year-end, expecting flows through the Strait of Hormuz to normalize soon and the US and Iran to reach an agreement in the coming months. However, what remains of oil reserves cannot compensate for another significant price spike, other analysts say.

The oil market remains dangerously exposed to the next shock, with current inventories too low, analysts at Energy Aspects said at the end of June. Moreover, the sharp decline in China's crude oil imports will begin to reverse at some point, as only part of the decline is structural, they noted. At the same time, US crude oil inventories, including the Strategic Petroleum Reserve (SPR), are at their lowest since 1985, "no buffer left to absorb a return in demand," according to Energy Aspects.

China Will Eventually Return to Purchasing

China's return to trading purchases will also be a major story for the market. China's oil imports fell for the fourth consecutive month in June, with crude oil arriving by sea dropping to just over 6 million barrels per day (bpd), the lowest since at least 2016, according to Vortexa data.

This will eventually recover, even if the structural change may not bring China's import demand back to pre-war levels, said Pamela Munger, Head of EMEA Market Analysis at Vortexa. The process of rebuilding Asia's vast reserves will be gradual rather than a buying spree, the analyst noted.

Until reserves are rebuilt, any changes in tensions, negotiations, and sanctions between the US and Iran will continue to leave the oil market vulnerable to another disruption and oil prices to another price spike.

Conclusion and Outlook

The oil market is at a critical juncture. While the resumption of flows through the Strait of Hormuz and negotiations between the US and Iran are putting downward pressure on prices, the situation remains highly uncertain. Global inventories are at low levels, creating high risk of price volatility. The recovery of demand from China and other countries will also be a crucial factor shaping the market in the future.

Investors and analysts will need to closely monitor the progress of US-Iran negotiations, the situation in the Strait of Hormuz, and the pace of global oil demand recovery to make appropriate investment decisions. In the short term, the market may continue to face downward price pressure, but in the long term, the recovery of reserves and demand could create a more complex picture.

By Tsvetana Paraskova for Oilprice.com