In less than a week, Brent has recovered from just above USD 90/bbl to back over USD 100/bbl. In our view, this most likely reflects the initial response to the step up in rhetoric over the Strait of Hormuz which has been quite aggressive and was further ramped up yesterday with news of a build up of US naval capacity in the Gulf.
As previously discussed, we doubt this round of bellicose behavior will prove as price impactful as it was at the start of the year, provided it stays at the level of rhetoric, which we believe is likely. It remains our view that any attempt to close the Strait of Hormuz by Iran would draw a withering military response because the loss of energy supply from such a closure would be of globally strategic proportions. It would also hurt countries which are more supportive of Iran’s position, such as China, as well as cutting off Iran’s own exports. Consequently, we do not believe the current bounce in the Brent price necessarily marks a definitive end to the current sell-off. For that to happen, we believe supply needs to be reduced more in line with demand. The level of global over-supply is likely to fall sharply in 2H12 as first, non-OPEC supply falls for seasonal maintenance and then, as demand grows seasonally with winter. That over-supply currently looks likely to be around 1mmb/d. As many commentators appear to believe that new sanctions will cut Iranian supply by 1mmb/d that would be a justification for prices to stabilize around the USD 100/bbl level. However, we continue to be of the view that the impact will be considerably less but, with the outlook now more finely balanced, an imminent return to the downside could be delayed, we believe.