Oil prices plummeted nearly 7% on Monday, with Brent crude futures falling $7.24 to $96.30 a barrel and US West Texas Intermediate CLc1 futures dropping $6.30 to $90.88. The decline was attributed to growing optimism that the United States and Iran were moving closer to a peace deal that would reopen the Strait of Hormuz, a critical oil shipping route. However, trading volumes were light due to the US Memorial Day holiday, which may have contributed to the lack of market activity.
The potential deal with Iran has sparked hopes for an end to the three-month-old war and the reopening of the Strait of Hormuz, which has been closed since January 2020. Both sides have expressed confidence in their ability to reach a final agreement within 60 days, but analysts caution that the process will take time.
Despite the optimism surrounding the talks, some experts remain skeptical about the prospects for a deal. Rory Johnston, founder of the Commodity Context newsletter, noted that previous negotiations had collapsed on details, and Hormuz remains closed.
The US President has also weighed in on the situation, saying that talks with Iran are going 'nicely' but warning of fresh attacks if they failed. He urged more Arab and Muslim states to sign up to the Abraham Accords, which aim to normalise ties between Arab and other Muslim-majority states and Israel.
The potential deal with Iran could lead to a significant reduction in risk premium in the Middle East, especially if Iran gives up its nuclear material. This, in turn, could boost oil prices as investors become more confident about the region's stability.
In contrast, Iran's foreign ministry has stated that it is not currently discussing nuclear issues, and analysts expect a return to normal oil flows through the strait to take months after any peace deal is reached.
The underlying supply shortfall of 10-11 million barrels per day of crude oil does not go away immediately, and will see markets still drawing inventories until Middle Eastern crude production is back online. This could lead to continued market volatility in the short term.
Ship-tracking data has shown that some tankers have passed through the strait in recent days, heading to Pakistan, China, and India, as well as a supertanker with Iraqi crude for China after being stranded for nearly three months.
The physical oil flows remain restricted, and analysts will continue to monitor the situation closely. The key factors for the oil market to watch should be the physical oil flows, and so far, flows through the strait have remained restricted.
Even if a peace deal is reached, it may take several months for normal oil flows to resume, as damaged oil and gas facilities are repaired. In the meantime, investors will continue to monitor the situation closely for any signs of progress or setbacks.
A significant reduction in risk premium is expected if a deal with Iran can be done.
