Although the US administration will never admit it, there are no winners in the latest Persian Gulf hostilities. For there to be one, the other side would need to surrender unconditionally, and the Memorandum of Understanding agreed at the end of last week and due to be signed on Friday is anything but that. The conflict has proven to be an unnecessary excursion that has resulted in a volte-face by its instigator. No matter how the agreement is packaged and sold, it appears to be the only option left for the US and its President. It is far from the best outcome; rather, it is the least inauspicious one, which has, in fact, provided Iran with considerable leverage. The agreement will inevitably lead to flexible and creative interpretations, which will have a direct impact on the more consequential nuclear talks expected to take place over the next 60 days. These negotiations could also be derailed by the far-right fringes of the political spectrum across all parties involved: Iranian extremists, Israeli hardliners and Republican Iran hawks.

For now, nonetheless, the best-case scenario must be assumed, and one can only hope that the weekend's de-escalation will not be followed by a resurgence of hostilities in the region. The current baseline is that the Strait of Hormuz will reopen and that ships will begin transiting through this critical chokepoint in both directions. The gradual resumption of oil flows, however slow, will materially affect the oil balance. The salient question is by how much. No doubt the views formed over the last three days will be revised as fresh developments emerge. The immediate prognosis, it seems, is optimistic and assumes no significant setbacks. Over the last four trading sessions, Brent, for example, has fallen by $17/bbl, a discernible vote of confidence that the worst, at least as far as supply disruptions are concerned, is behind us. This decline is not merely a reduction in the geopolitical risk premium; it is a recalibration of the global oil balance for the months ahead.

This reassessment is reflected in analysts' updated price estimates. Three investment banks have revised their oil price forecasts downward. As the US and Iran agreed to talk rather than fight, Goldman Sachs lowered its 4Q Brent price forecast by $10/bbl, from $90/bbl to $80/bbl. Its projection for next year was also reduced from $80/bbl to $75/bbl. Goldman now expects oil exports from the Persian Gulf to normalise by the end of July, a month earlier than previously anticipated. Citi sees Brent to average $75/bbl and $70/bbl in 3Q and 4Q, respectively, while its 2027 forecast has been lowered from $80/bbl to $65/bbl. Its new base-case scenario, assigned a 60% probability, assumes normalised oil flows through the Strait of Hormuz by the end of July, if not slightly earlier. The current Brent forward curve implies averages of approximately $77.60/bbl and $76.00/bbl for 3Q and 4Q, respectively, while the 2027 average is around $73.70bbl. Morgan Stanley sees a balanced market in 4Q, with Dated Brent averaging around $90/bbl in 3Q and $80/bbl in 4Q. In its view, supply will exceed demand by 2.4 mbpd in 2027.

These forecast reductions, in light of the Strait's reopening, are undeniably justified; only their magnitude is open to debate. They will, however, be subject to continual revision, as there are myriad moving parts in the equation, chief among them the capricious policymaking of the US President. An alternative approach would be to compare the current fundamental backdrop and price levels with those that prevailed before the crisis and attempt to determine whether the market overreacted to the announcement of the interim agreement aimed at securing a sustainable peace. Perhaps the best place to begin is with the weekly changes in the US oil market. After all, the US remains both the world's largest consumer and producer of oil.

WTI outright prices are currently some $5/bbl higher than they were at the end of February. The M1/M7 WTI spread, at around $4/bbl, is also somewhat stronger than its level of $2.40/bbl three and a half months ago. During the same period, US commercial oil inventories have declined by 58 million bbls and now stand 30 million bbls below their year-ago level. All the while, demand has held up reasonably well and remains comfortably above 20 mbpd. The combined effect has been a substantial decline in stocks as measured by days of forward cover. This snapshot can be extrapolated to the global oil balance and inventories.

The US, which proved an invaluable swing exporter of crude oil and refined products during recent turbulence, may reduce its overseas shipments as the Strait gradually reopens. However, clearing mines and vessel backlogs in the Gulf, while restoring the confidence of shippers and insurers, will take time. Some analysts believe that 80% of pre-war flows will be restored by the end of 3Q, later than the timeline envisaged by the investment banks. Others project full normalisation only by the end of 2026 or even 2027. Replenishing depleted inventories may take longer than the current euphoria suggests, and stocks could continue to decline for several months, albeit at a slower pace. The recent price weakness may therefore prove temporary, particularly if demand remains resilient or even strengthens.

Nearing Pre-Conflict Levels

Given the market's reaction to the preliminary ceasefire deal, it would be an act of brazen ignorance to insist that numbers do not lie. Despite the anticipated inventory drawdown (the API reported yet another deep crude oil draw last night), oil prices are now within spitting distance of their end-February levels, as the weekend's announcement triggered a fierce wave of selling, whether human-driven or algorithmic. Brent is $6/bbl above its pre-March level, and its front-end backwardation has collapsed completely. It plunged from $4.70/bbl a month ago to just 13 cents/bbl this morning. US retail gasoline prices dipped below $4/gallon. Clearly, the market expects considerable additional volumes of oil to reach international buyers. Iran, according to reports in the WSJ, will be allowed to resume crude oil exports immediately after signing the agreement.

With oil prices tumbling, inflation expectations are likely to decline, while increases in consumer and producer prices should moderate. Although the Fed is expected to leave interest rates unchanged today, expectations for rate increases in the second half of the year will be reassessed. Investor sentiment has shifted markedly in anticipation of the imminent reopening of the Strait. Despite this U-turn, however, a chaotic trading environment is likely to persist. Whether the recent optimism can be sustained remains to be seen—and we have our doubts, for the reasons outlined above. What is nevertheless strikingly obvious is the enduring, strategic significance of oil to geopolitics and the global economy.

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