Oil Cushion Dwindles as Central Banks Remain Hawkish

The Iran conflict has been ongoing for five months, and despite frequent 'TACOs' (talks about talks), there's still no end in sight. Yet, oil prices fall, and major stock indices like the S&P 500, Nasdaq, and Dow Jones rise every time headlines suggest a return to negotiating tables. This phenomenon can be attributed in part to inventories.

Before the conflict, markets had a cushion. The IEA expected a production surplus in 2026 with around 8.2 billion barrels in storage, and China had stockpiled crude for months. When flows through the Strait of Hormuz dropped from 20 million barrels a day to just 2.7 million barrels a day between March and May, this cushion helped avoid an immediate supply shock.

However, that cushion is running out: OECD public reserves are at their lowest since 1990, while the U.S. Strategic Petroleum Reserve is at its lowest level since 1983. The IEA estimates the market could face a deficit of nearly 900 million barrels by September. Rebuilding those reserves would require adding around 1 million barrels a day for three years.

Major central banks remain hawkish, with the Fed voting to hike rates and markets pricing in over a 60% chance of a rate hike in September. The Bank of England also backed a hike, while the Bank of Japan warned that persistent inflation risks could require further tightening.