The oil market is weathering the Iranian conflict admirably well, given the substantial supply deficit caused by the closure of the Strait of Hormuz. CME Group’s front-month WTI has lost more than $30/bbl from its April peak to the end of May, even though global oil inventories are estimated to decline by 7.5 mbpd in the second quarter and 3.5 mbpd in the third quarter – figures that remain subject to considerable revision should hostilities persist.

Several related factors are cited to explain this relaxed investor attitude. These include the easing of sanctions on sizable volumes of Russian and Iranian oil already afloat, a noticeable slowdown in Chinese oil purchases and demand destruction driven by rising oil prices in March and April.

Lastly, the global effort coordinated by the International Energy Agency (IEA) is also deemed to be helping mitigate the harmful impact of the Iranian conflict. In March, the IEA's 32 member countries agreed to a historic, record-breaking collective release of 400 million barrels of oil from strategic and emergency inventories in an effort to stabilise the oil market.

The United States committed to releasing the largest portion, 172 million barrels, from its Strategic Petroleum Reserve (SPR). As illustrated in the accompanying chart, the move has ostensibly achieved its declared objective: as the SPR has been depleted, not only have outright prices fallen, but the structure of the U.S. crude oil market has also weakened considerably.

The support provided by the SPR release could, nonetheless, prove fleeting. It is noteworthy that, of the 172 million barrels, 107 million barrels have already been awarded by the Department of Energy (DoE). Yet, according to the Weekly Petroleum Status Report, SPR inventories have declined by a mere 50 million barrels since March.

This is, indeed, a seemingly perplexing development. The SPR release operates as an exchange programme under which participants "borrow" oil from the DoE, market it and return it at a later date. Given the backwardated nature of the crude oil market, this arrangement offers participants a virtually risk-free profit opportunity, as they can sell the SPR oil immediately while simultaneously hedging subsequent purchases at significantly lower prices.

The catch, however, is that borrowers must return the oil with a premium of around 20%, meaning they are required to put more oil back into the SPR than they originally borrowed. This volume imbalance leaves potential bidders unable to hedge their subsequent physical purchases accurately, contributing to the undersubscription of DoE offerings. Another factor behind the lukewarm uptake of SPR barrels is the limited capacity of commercial terminals to receive and redirect these additional volumes.

A myriad of factors influence both the oil balance and, perhaps more importantly, market sentiment. The current system under which SPR barrels are exchanged is unlikely to offset Iranian supply disruptions as effectively as originally intended.