Oil - Some Back of the Envelope Math
The world uses about 103 million barrels of oil per day. Before the Iran War effectively closed the Strait of Hormuz, about 20 million barrels per day flowed through it. How has the oil market made up the shortfall?
- The IEA (International Energy Agency), which consists of 32 member countries including the U.S., coordinated the release of about 400 million barrels of oil from government reserves, equal to roughly 2.5 to 4 million barrels per day. Outside of the U.S., most of those reserves have now been exhausted.
- Before the war, the world had about 2.8 to 3.0 billion barrels of commercial (non-government) oil reserves. About 400 to 500 million barrels of those inventories have already been tapped, equal to roughly 3 to 4 million barrels per day. Around 2 billion barrels is considered a practical floor because storage tanks require a minimum level of oil to operate efficiently.
- Saudi Arabia, and to a lesser extent the United Arab Emirates, partially bypassed the Strait of Hormuz by moving more oil through pipelines, adding about 3 to 4 million barrels per day.
- Oil production increased elsewhere by another 4 to 5 million barrels per day.
Although the price of oil has risen from about $60 to roughly $80 per barrel, these measures are the reason prices have not surged significantly higher. Unfortunately, reserve releases cannot continue forever, and the Houthis, an Islamist rebel group in Yemen, are now attacking shipping in the Red Sea, disrupting some of the Saudi exports that were rerouted around the Strait of Hormuz.
The U.S. and China hold most of the world's remaining government and commercial oil reserves. Here are some back of the envelope calculations on how quickly those reserves are being drawn down.
U.S. -- The Strategic Petroleum Reserve has fallen from about 415 million barrels in late February to 311 million today. It continues to decline by roughly 5 million barrels per week. U.S. commercial reserves have fallen from about 440 million barrels to 410 million, but they have been relatively stable over the past month.
China -- Exact figures are hard to come by, but the Chinese government reportedly holds about 360 million barrels in strategic reserves, while commercial inventories are estimated at 800 million to 950 million barrels, down from about 1 billion before the war. So far, the drawdown has come almost entirely from commercial inventories, which are declining by roughly 1 million barrels per day.
The U.S. government can continue drawing from the Strategic Petroleum Reserve until it reaches about 252 million barrels. This is the statutory threshold set by Congress, after which additional authorization may be needed to continue withdrawals. Around that same level, operational limits also begin to emerge. Pumping becomes more difficult because of cavern geometry, pressure issues, pipeline constraints, and increased sediment mixing as oil levels approach the bottom of the storage caverns. At roughly 150 to 200 million barrels, there is also a risk of damaging the integrity of the caverns themselves.
On the commercial side, it’s estimated that U.S. refiners, pipelines, and storage facilities need at least 350 million to 375 million barrels of oil in inventory to operate efficiently. That means the current commercial reserve of about 410 million barrels is already approaching its practical operating threshold.
China is unlikely to draw down its 360 million barrel government reserve. Most analysts estimate that its commercial inventories also have a practical floor of roughly 500 to 700 million barrels. That gives China somewhat more flexibility than the U.S., but neither country can sustain these drawdowns indefinitely.
With no resolution to the Iran War in sight (the Oman/Iran negotiations are unlikely to produce a comprehensive peace agreement), government and commercial oil reserves continuing to dwindle, and the Houthis disrupting the Saudi exports that had been diverted around the Strait of Hormuz by pipeline to the Red Sea, we see a clear risk that oil prices could rise much further in the coming months. Accordingly, we've taken a position in XLE, one of the largest low-cost energy exchange-traded funds (ETFs), to hedge that risk in the PASI stock portfolio. While we don't view this as a long-term position given the secular headwinds facing the oil industry, particularly the growth of electric vehicles and gradually rising production costs, we see it as necessary insurance in the increasingly likely event the conflict in Iran remains unresolved.
