The world is running down its oil reserves

The chief executive of Saudi Aramco told an energy conference in Riyadh on 11 May that the world is using up its emergency stocks of crude and refined products at a rate it cannot keep up. He did not dress the message up. On his account, the buffer that keeps the industrial economy running is shrinking fast, and it has a limit.

Running the numbers

The Strait of Hormuz has been closed to commercial shipping for more than two months, and the cumulative shortfall in global oil supply has passed 1.2 billion barrels. Until now the gap has been filled by hurried withdrawals from commercial storage hubs, refinery working stocks and government strategic reserves. Aramco's figures show commercial crude inventories at thirty-year seasonal lows. In Europe and Asia they are nearing the minimum levels that tanks need to operate.

The figures hang together. A shortfall of 1.2 billion barrels built up over a little more than two months implies a gap in the order of twenty million barrels a day, roughly the volume that normally leaves the Gulf through the strait. Little of it can be rerouted. Saudi Arabia can send some crude west by pipeline to the Red Sea, and the United Arab Emirates can pump some to Fujairah outside the strait, but neither line was built to carry the whole load, and most of the world's spare production capacity sits in the same Gulf fields that are cut off.

Bigger than the 1970s

No earlier disruption comes close in volume. The Arab embargo of 1973, the Iranian revolution of 1979 and Iraq's invasion of Kuwait in 1990 each removed a few million barrels a day from the market, and each produced a price shock that reshaped economic policy for years. The 1973 embargo alone roughly quadrupled the price of crude. A loss several times larger than any of those, absorbed so far almost entirely out of storage, has no real precedent to calibrate against.

What the reserves can do

Government stocks were designed for this, though not at this scale. Members of the International Energy Agency must hold emergency stocks equal to at least 90 days of their net imports, and the agency co-ordinated releases in 1991, 2005, 2011 and twice in 2022. America's Strategic Petroleum Reserve is designed to release at most about 4.4 million barrels a day, and it entered this crisis well below capacity after the large sales of 2022. Stocks come out only as fast as pumps and pipelines allow, so the rate of withdrawal matters as much as the size of the stock. America's reserve also holds only crude, which still has to pass through a refinery before it can fuel a lorry.

The futures market is speeding the drain. When near-dated oil trades well above later contracts, a market structure called backwardation, a company holding a barrel in storage loses money by keeping it, since it could sell today for more than the price it can lock in for next year. Commercial holders therefore empty their tanks as fast as they can, which is the right response to a short disruption and the wrong one to a long one. Nobody is paid to hold a precautionary barrel.

Tank bottoms

Once tanks fall to those levels, pipeline pressure drops and refineries have to shut down in a hurry to avoid damage to their equipment. Stock draws can cover a deficit of twenty million barrels a day for a while, but not for ever.

The exposure is uneven. America, a net exporter of oil and refined products, can lean on its own production, although its prices still follow the world market. Japan and South Korea take most of their crude from the Gulf and have few alternatives close at hand, and European refiners compete with them for every cargo from the Atlantic basin. Those are the places where working stocks will hit the floor first.

That unevenness creates political pressure of its own. America lifted its ban on crude exports in 2015, and its shale fields and Gulf Coast refineries now supply buyers across Europe and Asia. If domestic prices climb while barrels leave for foreign ports, calls to restrict exports will grow. Any such restriction would ease American pump prices at the cost of deepening the shortage abroad and fracturing a market that has priced as a single pool for decades.

Price before rationing

The case against the warning is that prices ration long before tanks run dry. Demand fell sharply after oil touched $147 a barrel in 2008, and a shortage of this size would push prices high enough to idle factories and ground flights, narrowing the gap on its own. The messenger also has an interest, since a producer's chief executive gains little by sounding relaxed about supply. Both points are fair, but demand destruction on this scale is itself a form of rationing, and a disorderly one. When supply was cut in the 1970s, governments reached for odd-even petrol days, speed limits and car-free Sundays within months.

Rationing by price also falls hardest on those least able to pay. Poorer importing countries, which cannot outbid Japan or Germany for scarce cargoes, will find physical supply drying up before prices in rich markets reach their peak. The shortage will show first as queues and power cuts in South Asia and Africa, and only later as closed plants in the industrial economies.

Signals to watch

The indicators to watch are the weekly inventory figures from America's Energy Information Administration, the International Energy Agency's monthly oil report, and the premium of near-dated oil futures over later contracts, which widens as buyers pay up for barrels today. A further co-ordinated release by the agency's members would show whether governments expect a long closure, and its daily rate, set against a gap of twenty million barrels, would show how much time it buys. Any reopening of the strait would change the call at once. If Hormuz stays shut, inventories are likely to run out before the year ends, and governments will then have to ration fuel to industry.