The global oil market in transition

The war in Iran has triggered the largest oil-supply disruption in modern history and the crises is forcing governments to redefine energy security for an age of geopolitical fragmentation. It is not only the situation in Iran and the Hormuz Strait that is impacting the global oil market, other factors are the conflict in Ukraine, a more assertive U.S. energy strategy, the regime change in Venezuela and the weakening of OPEC.

The conflict in Ukraine triggered the biggest reordering of global oil and gas trade in decades. Before the conflict started, energy markets were relatively integrated. Russia sold huge volumes to Europe, prices were broadly set in a global market, and shipping routes were stable. Since then, the system has become more fragmented, political, and regionalized. Europe sharply reduced purchases of Russian crude and refined products through sanctions and embargoes. But Russia largely rerouted exports to Asia, especially India and China. Europe was Russia’s main oil and gas customer and India bought relatively little Russian crude, whereas today India became one of the biggest buyers of discounted Russian oil and China increased imports too.

Europe replaced Russian barrels with supplies from the U.S., Middle East, Norway, West Africa, and Latin America. The main problem for Europe is that this has resulted in significantly higher costs, impacting both manufacturers and consumers. Crude prices remain elevated above $100 a barrel and is expected to move higher as inventories run dry. Asia has been hit first and hardest, followed by Europe. Asia relies on the Middle East for roughly 60% of its imported oil. The disruption has been severe not only for crude oil, but also for refined products like diesel and jet fuel. For Europe with its self-destructive energy policy, it means higher costs, lower profits and more headaches for the manufacturing sector. The overall energy transaction costs have gone up significantly impacted by tanker demand, shipping insurance costs and freight rates.

The West, led by the U.S. and Europe have for years, since the conflict in Ukraine started, tried to change the market by imposing new sanctions and restrictions on Russia to keep oil flowing and to cut Russia’s profits in order to undermine the Russian economy. The G7 and EU introduced a price cap on Russian oil in late 2022. The idea was to avoid a global supply shock, but force Russia to sell at a discount. That partially worked short-term as Russian crude traded at steep discounts to Brent with Russian revenues falling, but export volumes stayed surprisingly resilient by Russia’s pivot to Asia, using non-Western shipping and insurance, rerouting sales through intermediaries and long-term Russia will have replaced Europe with Asia and likely growing global market shares and revenues.

Two decades ago, the U.S. imported around 60% of the oil it consumed. Today, it is the world’s largest oil producer and a major net exporter. Oil use as a share of the economy has also steadily fallen in recent decades. The surge in supply means that physical shortages will take longer to reach American shores. Consumers will pay more for gas, but the broader macro-economic damage Is smaller because increased consumer spending at the pump now flows to domestic producers rather than abroad. Plus, natural gas prices surged in Europe and Asia but barely rose in the U.S., a price divergence that has saved U.S. consumers billions since the onset of the shale revolution.

The U.S. became arguably the biggest geopolitical and commercial winner as U.S. oil exports rose, LNG exports surged, Europe became more dependent on American energy, and U.S. producers benefited from higher prices and stronger demand. American LNG companies especially gained from Europe’s rush to replace Russian gas. India has also emerged as a major refining and trading winner. India bought discounted Russian crude, refined it into fuels like diesel, and exported products globally, including at times back into Europe indirectly. Cheap feedstock improved refinery margins and reduced import costs. China gained access to discounted Russian energy and strengthened its strategic relationship with Moscow. It also benefited from being one of the few giant buyers outside the Western sanctions system such as Dubai, Singapore, and some Greek shipping interests became more important hubs. Countries like Saudi Arabia and the United Arab Emirates benefited from stronger geopolitical leverage, higher prices and increased importance as alternative suppliers to Europe.

Europe has been the biggest short-term economic loser in the evolving oil market as it faces huge energy price spikes, industrial competitiveness problems, inflation, higher electricity and heating costs and expensive LNG imports. Germany in particular has lost access to cheap Russian pipeline gas that had supported its manufacturing base for years.

One can also argue that Russia avoided the catastrophic collapse many expected, but it still lost its premium European market, pipeline leverage over Europe, pricing power, billions in revenue through discounts. It now depends much more heavily on China and India as buyers. Russia preserved volumes but often at lower profitability.

There has been a geopolitical shift as energy security has become more important than pure efficiency. Governments have realized that they need supply diversification, domestic production, strategic reserves, politically reliable suppliers. This means an increasingly fragmented market here is with a Western-sanctioned market, and a parallel market centered on Russia, China, India, and non-Western shipping networks. This system is now more exposed to geopolitical shocks, in particular in the Middle East, Red Sea shipping disruptions, and sanctions conflicts. This fragmentation will create more volatile markets and keep prices higher as markets and alliances might shift. The global oil market is in continued transition and this will likely continue as energy consumption continues to increase across the globe.