Analysts suggest that once the current supply shock is resolved, the US, and even the global market, will face a strong wave of restocking demand.

Crude oil transit through the Strait of Hormuz has yet to normalise, and international oil prices have not surged as sharply as the market had previously feared. As of July 29, Brent crude oil was priced at $80.42 per barrel, down more than 6% from a week earlier, but it still maintains a gain of nearly 10% over the past month.

However, the price buffer is narrowing. The US Strategic Petroleum Reserve (SPR) and commercial inventories are being depleted at a rate not seen in decades. Data from the US Energy Information Administration (EIA) shows that as of the week ending July 17, total US commercial crude oil inventories and the SPR had fallen to their lowest level since 1984. The SPR itself has dropped to its lowest point since 1983, standing at approximately 308 million barrels in the latest week.

Why the inventory drawdown matters

Roukaya Ibrahim, Chief Commodities Strategist at global investment research firm BCA Research, said during a recent seminar that global oil inventories are currently being depleted at a rate of nearly 4 million barrels per day. As stocks are further drawn down, the buffer for the US to cope with future supply shocks will narrow sharply, increasing the vulnerability of the global crude oil market.

Could the "critical alert line" be reached before year-end?

Ibrahim noted that open interest in crude oil futures briefly surged at the onset of the crisis before declining significantly. Although it has rebounded somewhat with rising geopolitical tensions, net speculative positioning as a percentage of open interest remains at historically low levels. In her view, these two data points together indicate a lack of confidence in the market's pricing direction for crude oil and suggest that most traders have not truly prepared for the risk of a prolonged supply disruption.

The "temporary optimism" is currently supported by several ad-hoc absorption channels. Under normal conditions, the Strait of Hormuz handles approximately 20 million barrels per day of crude oil transit. Since the onset of the Middle East crisis, this passage has been largely blocked. Ibrahim breaks this down, explaining that roughly 2 to 3 million barrels per day of crude oil are still able to exit the strait secretly by turning off ship transponders. Pipeline diversion routes absorb about 5 million barrels per day. Additionally, a supply surplus of over 3 million barrels per day that existed in the market before the crisis has been directly consumed, partially filling the gap.

Beyond these mechanisms, there is also a layer of international coordination buffer. Shortly after the crisis broke out, the 32 member countries of the International Energy Agency (IEA) unanimously agreed on March 11 to launch the largest coordinated emergency stockpile release in history, totalling 400 million barrels of oil reserves. This action was taken to offset the supply gap caused by the disruption in the Strait of Hormuz, with the US SPR release being a component of this coordinated effort.

De-stocking and demand destruction have also played significant roles. Ibrahim stated that global inventories are currently being drawn down at a rate of nearly 4 million barrels per day, while global crude oil demand has decreased by about 5 million barrels per day due to a sharp drop in imports.

"These stock releases are temporary in nature and cannot be sustained indefinitely," she cautioned. She expects that once the strait resumes normal operations, the inventories that were drawn down will transition into restocking demand, and the suppressed demand will also recover. Both factors will then shift from being forces that suppress oil prices to forces that push them higher.

Signs of disconnect in the refined product market

Signs of this disconnect have already appeared in the refined product market. Ibrahim analysed that during a brief ceasefire period, the decline in retail gasoline prices was far smaller than the decline in crude oil prices. Both gasoline and diesel inventories are at historically low levels, and crack spreads have been widening. She attributes this to regional export restrictions tightening the supply of refined products in some markets, as well as declining refinery utilisation rates, forcing crude oil to be stored as floating storage at sea.

Ibrahim specifically warned that if floating storage is excluded, observable onshore crude oil inventories globally have actually been depleting rapidly and will hit a "critical alert line" before the end of this year.

How long can the SPR's 'borrow and return' buffer last?

Regarding the US inventory situation, Ibrahim stated that many market participants mistakenly believe the increase in US crude oil exports is due to rising domestic production. However, this is not the case. "The entire increase in exports comes from the significant drawdown of US commercial inventories and the SPR."

She noted that the market typically views 250 million barrels as a key reference line for the SPR. According to the US Energy Policy and Conservation Act (EPCA), if the SPR falls below this level, certain withdrawal authorities would be restricted. As of the latest week, the SPR stands at about 308 million barrels, leaving just over 50 million barrels of space before this reference line is reached.

Furthermore, a recent audit report from the US Government Accountability Office (GAO) stated that, according to US Department of Energy estimates, the actual effective withdrawal and injection capabilities of the SPR are only 61% and 56% of its design rates, respectively. Over a quarter of the inventory is "unavailable for extraction" due to cavern maintenance and facility failures. This means that even if the book inventory number has not yet fallen below the statutory threshold, the actual emergency capacity that the SPR can quickly mobilise may be even tighter than the numbers suggest.

Ibrahim emphasised that as inventories are further drawn down, the buffer for the US to handle future supply shocks will narrow sharply, increasing the vulnerability of the global crude oil market. She stated that based on the depletion rate of global observable inventories from March to May of this year, global onshore crude oil inventories could reach a critically high-risk operational tipping point before the end of this year. This is the most important time window to watch when judging whether inventory depletion will lead to a sharp oil price spike this summer.

Importantly, Ibrahim explained that the US SPR withdrawal mechanism operates on a "borrow and return" basis, meaning that the stockpiles used must be fully replenished in the future, along with an additional 20% interest. This implies that once the current supply shock is resolved, the US, and even the global market, will face a strong wave of restocking demand. This factor will transform from a force suppressing oil prices into a force supporting a price floor.

US domestic production response is slow

Compared to the rapid depletion of inventories, the response of US domestic production is much slower. According to a survey by the Federal Reserve Bank of Dallas, the vast majority of surveyed executives expect US crude oil production to increase by only 250,000 barrels per day in 2026. Compared to the 20 million barrels per day of disrupted supply, this increment is almost negligible in filling the gap.

Based on this, Ibrahim concludes that even if the Strait of Hormuz transit is eventually restored, the numerous mechanisms previously used to suppress oil prices will shift to supporting the demand side. Fundamentals will still support Brent crude oil prices above $70 per barrel, making it difficult for prices to fall significantly again.

Transmission path to US inflation expectations

For US consumers and policymakers, the more important factor is the transmission path to inflation expectations. Matt Gertken, Chief Geopolitical Strategist at BCA Research, also noted that as core components like wage growth and housing inflation continue to slow, the US core inflation rate is expected to remain near the Federal Reserve's target, and market-based inflation expectations remain largely anchored.

However, he cautioned that exogenous shocks, such as the Strait of Hormuz crisis, are "temporary supply shocks" that directly raise consumer inflation expectations for daily living costs, particularly evident in fuel and food prices.

Ibrahim added that the current "super El Niño" cycle is placing additional upward pressure on food and fertiliser prices. She mentioned that, based on a recent team report, there is a strong correlation between the Oceanic El Niño Index and agricultural commodity prices. Among specific crops, "wheat and palm oil have been the most impacted by El Niño historically." According to a "crop vulnerability score" survey report, which comprehensively assesses current inventory levels of various agricultural products, wheat and palm oil are identified as the two most vulnerable crops at present.

For frontier emerging markets that are highly dependent on food imports, this will not only fuel inflation but also impact domestic politics and society.

Gertken also believes that although the US has a high level of food security and overall inflation is unlikely to spiral out of control, this could still act as a catalyst amplifying domestic political conflicts. As the midterm elections approach, it will further increase the political pressure on the current administration regarding price issues.

Long-term outlook

Looking ahead to supply and demand dynamics, Ibrahim stated that while tight supply and restocking demand will support Brent crude oil prices above $70 per barrel over the next 1 to 3 years, the crisis has actually accelerated the long-term bearish trend for crude oil when taking a longer-term view.

"On the demand side, the crisis is prompting countries to accelerate policies aimed at reducing dependence on fossil fuels. The trend of electric vehicles is likely to be widely replicated in Asia and other regions globally, thereby suppressing crude oil demand in the long run. On the supply and logistics side, countries are accelerating the construction of pipeline facilities that bypass key straits to guard against future geopolitical crises. For example, the UAE plans to double its domestic pipeline capacity next year, and Saudi Arabia is considering expanding pipelines and building new routes. Therefore, the peak importance of the Strait of Hormuz for the global oil market has passed. It will remain important, but its future relevance will be lower than it is today," she said.