Oil prices defy headlines as war premium and supply risks keep Brent above $116

Brent crude is trading at over $116 per barrel, a level that significantly exceeds the fair value estimated by major financial institutions. This divergence between market prices and modelled valuations has rendered the question of oil’s true worth increasingly complex. While recent reports indicated that oil flows out of the Strait of Hormuz had recovered to pre-war levels, such developments have failed to sustainably lower prices. Instead, benchmarks are set for their fourth consecutive monthly gain, demonstrating that headline news regarding export volumes is no longer the primary driver of market sentiment.

The persistence of high prices is attributed to a combination of elevated shipping costs and significant maritime security risks. In the past few weeks, dozens of tankers have been targeted by drones or missiles, creating a hazardous environment for vessels transporting crude from the Persian Gulf. To mitigate the risk of attacks in the Strait of Hormuz or the Red Sea, Saudi Arabia has shifted to ship-to-ship transfers off the coast of Oman. This logistical adjustment has contributed to a shortage of available tankers, driving shipping costs to all-time highs. Consequently, producing countries have been forced to discount their oil to stimulate demand, even as reports of improving flows in the Gulf have applied downward pressure on prices. The underlying reality is that these improved flows are difficult to sustain in an environment where the threat of missile attacks remains high.

Analysts note that the war premium on oil remains robust, although it is not the sole factor influencing current valuations. In the early weeks of the conflict, the oil market reacted with unexpected optimism. Traders and observers widely believed the conflict would be short-lived, and the global market was awash with oil, providing a solid supply cushion. However, this modest price increase was largely confined to the futures market. On the physical market, oil prices surged immediately. It took several months for futures and physical prices to begin converging, a process that appears to be occurring now as physical prices retreat from their earlier highs. The challenge for those anticipating a return to sub-$100 Brent is that the global supply cushion has been exhausted eight months into the war. The prospect of peace remains elusive, and consumers are paying record-high prices for diesel. Current prices reflect these fundamental realities, unlike three months ago when market movements were driven primarily by political statements and reports of imminent peace.

The International Energy Agency has warned that the disruption to energy supplies is likely to continue well into next year. Fatih Birol, the head of the agency, stated that there is no credible pathway for markets to return to pre-war conditions. He suggested that the crisis would accelerate the transition towards what he termed the Age of Electricity, although sceptics argue that electricity prices remain closely tied to the cost of hydrocarbons used in power generation. Beyond these structural issues, prices are being held above $100 per barrel by anticipation of future geopolitical developments. Specifically, there is concern over potential escalation between the United States, Israel, and Iran. President Trump has admitted to considering a return to hostilities following the November 3 midterms, while Iran has threatened retaliation if a hot war resumes. Both sides appear prepared to resume fighting, despite ongoing diplomatic efforts by Gulf states and Pakistan.

With the midterms scheduled for next Tuesday, market participants are bracing for potential volatility. Most expect a renewal of hostilities in the Persian Gulf, which would likely result in a higher war premium and a further extension of the energy supply disruption that has defined this year. Until there is a clear sign that peace is a viable possibility, oil prices are expected to remain elevated, regardless of what analyst models suggest regarding fair value.