Is a Second Oil Shock Coming?

Overview

Sustained supply disruptions through the Strait of Hormuz due to the Iran conflict has sent oil prices higher. This in turn has elevated inflation and prompted a rise in interest rates. Mortgages, for example, dipped below 6% prior to the conflict and now stand at 6.5%. High interest rates are the largest adverse factor confronting construction activity.

The hindrances to shipping through the Strait, reduces world oil supply -- prompting a price increase. The full force of that supply disruption, however, has not been felt at the pump or more broadly on global economic activity.

Substantial commercial oil inventories across major importing nations were elevated heading into the conflict. In addition, large strategic petroleum reserves held by the U.S., IEA members, and Gulf allies provided an additional layer of insulation. Together, these oil stockpiles absorbed some of the shock - moderating the initial price spike.

But buffers are finite. As the shipping hindrance persists, those oil inventories are being drawn down at an accelerating pace. Weeks of disruption are doing what days could not --- gradually exhausting the cushion that softened the first blow. If the constraint on Hormuz shipping continues, markets may be left exposed at precisely the moment reserve capacity is thinnest.

The IEA (International Energy Agency) expects the steepest draws in history of oil inventories will materialize in May and June. UBS expects inventories to approach all-time lows by the end of May. Rapidan Energy predicts product inventories could hit critical levels in July or August. This all sets the stage for a potential second leg up in oil prices prior to the third quarter.

This all implies a worsening of inflation and even further elevation in interest rates. It also implies additional strain on consumer spending and overall economic growth and job creation. For private sector construction activity, already strained by elevated borrowing costs, could face further softening.

Clients should recognize that the forecast projections and assumptions upon which our Spring forecast (March 15^th^) was based, are increasingly deteriorating the longer the Iran conflict persists. Downside risk exists for the baseline Spring forecast. The odds of our pessimistic scenario are increasing.