I agree that markets are pricing-in early the risks associated with embargos. However, it does not necessarily mean those risks are contained.
The issue is not merely that there will be fewer Iranian barrels. The real concern is how a reduction in flow flexibility through freight, insurance, financing, etc., in the Gulf impacts deliverability. This moves the shock from supply to deliverability - an area where most standard elasticity frameworks can likely miss mark.
I notice that The Economist, taking a rather less sunny view of market efficiency, writes that "everyone—whether they deal in energy, bonds or stocks—seems to say the same thing: market pricing betrays a staggering optimism about a bad situation that could get an awful lot worse."
Does the 125$ barrel of oil take into account the Iranians and their Houthi friends working together to also stop sea traffic the way the Houthis did last year?
And you also seem to be tacitly assuming that attacks on energy infrastructure in the Gulf states won’t get much worse. It may turn out that way, but if US troops do invade say Kharg Island there could be much more solidarity activity from Arab populations than we have so far seen.
Markets need information to price accurately. There is damn little information available here. Just lots of guessing and assumptions. If the embargoes work then OK. If China demands their Iranian oil paid for in crypto or yuan then the assumptions shift.
…isn’t the primary risk that countries who have been receiving some of the oil trickling through decide to intervene when the trickle is fully shut off?
Pearl Harbor came after the US shut Japan out of the oil market.
How big of a risk is it that other countries intervene?
From what I understand, the 3-month forward contract for Brent is the benchmark for price. The June contract is now around 100 USD, but Sep at 84 and Dec 79. Does that imply markets are still pricing in a relatively quick (a matter of weeks) end of the war and slow ‘re-opening’ of the Strait? If a more permanent embargo occurs, perhaps due to a messier end of the conflict, do you expect the price to simply stay higher for longer rather than go much higher than your ~125 estimate?
The elasticity math is clean, but the binding variable is enforcement, not price. China currently imports roughly 1.5 million barrels per day of Iranian crude at steep discounts — about 90% of Iran's seaborne exports. In 2018-2020, "maximum pressure" sanctions never fully shut that flow; Chinese teapot refineries just switched to ship-to-ship transfers and renamed the cargo. If an embargo leaks the same way, the effective supply loss is closer to 500k bpd than 2 million, which on your own elasticity table barely moves Brent. The $120 number implicitly assumes a level of Chinese compliance that has no historical precedent.
Paul Krugman emphasizes in his today's posting that the physical supply of oil has not yet materially changed since substantial quantities are on 4-6 weeks journeys and have passed Hormuz long before it got closed. He correctly points to the fact that this will change shortly and the availability, and not just financial affordabiltiy, of oil will change. As far as I can understand, the embargo-idea does not include the big unknown - the military retaliation of Iran against an embargo. It cannot be predicted with certainty what they could and would do, but there is the military expectation that an embargo against Iranian oil would result in hits on oil producing installations on the Arab side of the Gulf, and could even hit the most critical civilian infrastructure there - desalination plants. An embargo of Iranian oil, as well as an occupation of Kharg Island by US-troops, could well have the unintended consequence that no or considerably less Arab oil could come to the market shortly. In an extreme case the Arab side of the Gulf could become uninhabitable within a matter of days. Whatever the Iranian reaction to an embargo would be, there would be an additional dimension to the the price develoment that does not yet seem to be included in this and in previous analysis.
Immediate thoughts are that 2 largest variables: markets moving based on words of one as unstable and emotional as Trump plus indubitable rage of Iran leaves room for uncertainty. Guessing both sides are using their AI models to game theory the heck out of this. How much do Trump and hegseth let rational minds weigh in.
I agree that markets are pricing-in early the risks associated with embargos. However, it does not necessarily mean those risks are contained.
The issue is not merely that there will be fewer Iranian barrels. The real concern is how a reduction in flow flexibility through freight, insurance, financing, etc., in the Gulf impacts deliverability. This moves the shock from supply to deliverability - an area where most standard elasticity frameworks can likely miss mark.
I notice that The Economist, taking a rather less sunny view of market efficiency, writes that "everyone—whether they deal in energy, bonds or stocks—seems to say the same thing: market pricing betrays a staggering optimism about a bad situation that could get an awful lot worse."
How many times have I heard that the market has priced something, to find out the market of et misprinted an event.
Does the 125$ barrel of oil take into account the Iranians and their Houthi friends working together to also stop sea traffic the way the Houthis did last year?
And you also seem to be tacitly assuming that attacks on energy infrastructure in the Gulf states won’t get much worse. It may turn out that way, but if US troops do invade say Kharg Island there could be much more solidarity activity from Arab populations than we have so far seen.
Ian
Markets need information to price accurately. There is damn little information available here. Just lots of guessing and assumptions. If the embargoes work then OK. If China demands their Iranian oil paid for in crypto or yuan then the assumptions shift.
…isn’t the primary risk that countries who have been receiving some of the oil trickling through decide to intervene when the trickle is fully shut off?
Pearl Harbor came after the US shut Japan out of the oil market.
How big of a risk is it that other countries intervene?
From what I understand, the 3-month forward contract for Brent is the benchmark for price. The June contract is now around 100 USD, but Sep at 84 and Dec 79. Does that imply markets are still pricing in a relatively quick (a matter of weeks) end of the war and slow ‘re-opening’ of the Strait? If a more permanent embargo occurs, perhaps due to a messier end of the conflict, do you expect the price to simply stay higher for longer rather than go much higher than your ~125 estimate?
The elasticity math is clean, but the binding variable is enforcement, not price. China currently imports roughly 1.5 million barrels per day of Iranian crude at steep discounts — about 90% of Iran's seaborne exports. In 2018-2020, "maximum pressure" sanctions never fully shut that flow; Chinese teapot refineries just switched to ship-to-ship transfers and renamed the cargo. If an embargo leaks the same way, the effective supply loss is closer to 500k bpd than 2 million, which on your own elasticity table barely moves Brent. The $120 number implicitly assumes a level of Chinese compliance that has no historical precedent.
Paul Krugman emphasizes in his today's posting that the physical supply of oil has not yet materially changed since substantial quantities are on 4-6 weeks journeys and have passed Hormuz long before it got closed. He correctly points to the fact that this will change shortly and the availability, and not just financial affordabiltiy, of oil will change. As far as I can understand, the embargo-idea does not include the big unknown - the military retaliation of Iran against an embargo. It cannot be predicted with certainty what they could and would do, but there is the military expectation that an embargo against Iranian oil would result in hits on oil producing installations on the Arab side of the Gulf, and could even hit the most critical civilian infrastructure there - desalination plants. An embargo of Iranian oil, as well as an occupation of Kharg Island by US-troops, could well have the unintended consequence that no or considerably less Arab oil could come to the market shortly. In an extreme case the Arab side of the Gulf could become uninhabitable within a matter of days. Whatever the Iranian reaction to an embargo would be, there would be an additional dimension to the the price develoment that does not yet seem to be included in this and in previous analysis.
Immediate thoughts are that 2 largest variables: markets moving based on words of one as unstable and emotional as Trump plus indubitable rage of Iran leaves room for uncertainty. Guessing both sides are using their AI models to game theory the heck out of this. How much do Trump and hegseth let rational minds weigh in.