Crude market: Brace for the inevitable oil bust

Philip Delves Broughton

When the US and Israel attacked Iran in February, a temporary surge in oil prices was a given. Seven months on, with international crude hovering around $100 a barrel and tankers still cowering in the Strait of Hormuz, drivers seem resigned to paying $5 for a gallon of petrol for the foreseeable future.

They needn’t be: oil’s big bust is coming. The stage is set for a price crash, and not the kind that would benefit President Trump before the midterm elections.

Oil busts happen first in drips, then in blowouts. In March, at the industry’s annual jamboree in Houston, executives celebrated how the Trump administration had simplified their lives. Regulatory approvals that used to take years were being waved through in days. Exploration and production were booming, and the price surge from war was plumping profits. Oil traders were feasting on the volatility.

Older heads, however, recalled a darker era. In early 1986, oil prices fell from roughly $30 a barrel to $10 after Saudi Arabia decided to flood the market to punish OPEC members flouting production limits. The combination of a US slump and the collapse in global crude prices dragged Houston into its own version of the Great Depression.

Pawnshops, bursting with furs and Rolexes, had to turn away consigners. In the evening, sunlight shone through empty skyscrapers, unfiltered by occupants or furniture. Former Texas governor John Connally filed for bankruptcy, selling his possessions at auction. The psychological scars were deep and lasting.

Something similar will happen if the Iran war ends and shipping resumes freely through the strait. Oil prices will retreat, initially to where they stood in January, around $60 to $70 per barrel. But a far more dramatic fall now looks likely, well beyond the cautious forecasts of supply and demand.

During the recession that followed the 2008 financial crisis, prices fell from around $140 a barrel to $40, and during Covid they plummeted from $60 to $20. A similar drop today could take crude to $30 and below. At that price, the Saudis could make money but not US oil producers.

US Commerce Secretary Howard Lutnick stated recently that the administration wants oil prices to collapse. The strategy is to open the spigots of global crude, starting in Venezuela, with the goal of $2-a-gallon petrol forever — which translates to crude pricing at $30 to $40 a barrel.

While an appealing campaign promise, a price that low would devastate the US energy sector. The break-even price for American oil producers drilling new wells is north of $60 a barrel; for shale drillers, even higher. In Lutnick’s scenario, the cheering oil barons of Houston, along with their workforce, would soon face economic Armageddon.

In a balanced market, the world produces and consumes around 105 million barrels of liquid fuels daily. This year, both supply and demand are down. The International Energy Agency’s (IEA) latest annual estimate projects global oil demand to fall by 2.5 million barrels per day, with supply dropping by 5.7 million barrels per day.

As the Persian Gulf chokes, Guyana, Argentina, and Venezuela are investing heavily to ramp up global oil and energy production. An end to the Ukraine war could bring much of Russia’s sanctioned oil out of the shadow fleets and back onto the open market. The question then will be whether there will be buyers for all this supply.

Meanwhile, champions of renewable energy are closer than ever to the tipping point where clean energy becomes cheap, reliable and available. This year, renewables, mostly wind and solar, are providing just over half the power consumed in California and Western Europe.

The primary hurdles remain storage and grid transmission. Yet oil’s persistent volatility provides the exact impetus investors need to accelerate the transition. Surging energy demand from Big Tech and AI giants is supercharging investment into alternatives, including small modular nuclear reactors.

The economic fallout of high oil prices is unevenly distributed. Asian economies, heavily reliant on Gulf crude imports, have suffered more in recent months than Western nations with regional supplies and diversified energy systems. In the 1970s, Japan adapted to quadrupling oil prices by pivoting to nuclear power.

Unpredictable US foreign policy has left many nations questioning whether reliance on oil — so dependent on Washington’s actions — is worth the hassle. Exasperated Middle Eastern allies are pivoting toward China, a massive oil consumer. Recent attacks on Saudi Arabia’s crucial east-west pipeline will disrupt supply for months, heightening the perception that this war has spun out of control.

There is also the prospect of recession, another demand killer. The simplest reading of the recent tremors in the bond markets is that winter is coming. The US and much of Europe are too deeply in debt. The AI bubble is a rogue agent or two away from deflating. Borrowing costs are rising, and a worldwide recession would dent demand for oil at a moment of rising supply.

When oil prices begin to fall, producers inevitably engage in a race to the bottom. They pump more to preserve revenue, but the excess supply drives prices down even faster. Higher-cost operators are squeezed out. The 1986 price collapse severely weakened the Soviet Union; a similar crash today could cripple Putin’s Russia.

Despite low production costs, Saudi Arabia cannot endure rock-bottom prices. Its population has nearly tripled since 1986, and its ambitious economic transformation requires massive capital. A severe economic shock in the Middle East would destabilise regional decision-making.

Across the global energy landscape, conditions are converging toward a major crude price collapse. It is merely a question of timing. While lower fuel prices will bring relief at the pump, the unwinding of the market promises severe disruptions for the energy sector and oil-dependent economies worldwide.