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      About 20% of the world’s oil and liquefied natural gas traverses the Strait of Hormuz, which is 21 miles across at its slimmest point; any disruptions to that flow would have a major impact on prices.
      Aref Judeh

      Partner — Audit

      KPMG in Kuwait

      Anatomy of an oil shock

      This edition of the Global Navigator takes a closer look at the risks of a spike in oil prices and how it could reverberate through the global economy. It is one of the top risks cited by our oil economist contacts, yet it gets limited play in the financial press. One reason is the ramp-up in oil production in the US and the role it has played as a buffer for some of the most recent large threats to global oil supplies, notably since the war in Ukraine.

      The US has been the largest oil producer in the world since 2018, hit a new record in 2023 and continues to act as a major buffer against a spike in oil prices. That has bred a sense of complacency about future oil shocks. However, there is no way the US alone could offset a blockade in the Strait of Hormuz, which is possible given escalating tensions in the Middle East. The oil and natural gas that traverses that narrow pass is nearly equivalent to all the production in the US, which accounts for more than 20% of global oil supplies.

      Situations we are watching

      An escalation of geopolitical tensions, including hot wars, could trigger a surge in oil prices. Tensions in the Middle East and threats to oil transport via the Strait of Hormuz represent a much larger potential shock to global oil supplies than Russia’s invasion of Ukraine. Prices could skyrocket to $140/barrel before settling back down to their forecasted $80 to $90 per barrel range.
      The US is currently the largest oil producer and primary buffer when prices spike, but it lacks the spare capacity to ramp up fast enough to offset a disruption in the Strait of Hormuz. Shale production has propelled US oil production to record highs. However, investment in new oil assets is limited by capital discipline – the push by oil producers to return profits to shareholders – and the incentives to invest in renewables. (Many of the oil producers are also the largest investors in renewables; they see themselves as energy companies.)
      Pressure on Iran to lift a blockade would be strongest from Asian economies, which are the most dependent on oil from the Middle East. Middle Eastern oil producers that have trapped exports, together with the US, would likely add to pressure from the Asian countries to reopen the Strait of Hormuz.

      Pinch points

      There are four potential drivers of a spike in oil prices:
      • Disruption to oil shipments via the Strait of Hormuz.

        About 20% of the world’s oil and liquefied natural gas traverses the Strait of Hormuz, which is 21 miles across at its slimmest point; any disruptions to that flow would have a major impact on prices. (See Figure 1.) Our sources in the oil sector estimate that oil prices could reach as high as $130 to $150 per barrel from the mid-$80 per barrel range today if such a blockade occurred. That is by far the most extreme scenario, as it would involve a major escalation of tensions in the Middle East. It is the only scenario that the US could not offset with a rapid increase in production. The US has filled the role as safety valve in oil markets in recent years, along with the traditional swing producer, Saudia Arabia, and helped to offset major supply shocks. The US played a particularly large role in offsetting the disruptions to Europe due to Germany’s dependence upon Russian oil when the latter invaded Ukraine.

      • A further escalation of the war in Ukraine.

        Ukrainian attacks on Russian refineries have caused Russia to scale back crude production to avoid a glut at the refining stage but, thus far, not dramatically disrupted the balance between the supply and demand for Russian oil. An expansion of targets could further disrupt supply, but the effects are in dollars not tens of dollars per barrel, given the ability of other countries to fill the gap left by Russia.

      • OPEC+ production cuts

        The Organization of Petroleum Exporting Countries plus (OPEC+), which includes twelve countries, have held to a cut in production amounting to 2-3% of global demand since September 2022. The challenge is that adherence to cuts within the bloc is weak, which has meant the cuts have done little more than create a floor under prices, rather than spur major increases. Saudi Arabia, the de facto leader of the group, and the world’s swing producer, has a relatively high breakeven price so elevated prices are welcome. 

      • Hurdles to the adoption of renewable and more sustainable energy sources.

        Governments the world over have adopted a combination of carrots and sticks to facilitate the adoption of renewable and more environmentally friendly energy sources. A sharp increase in interest rates to combat the post-pandemic inflation as well as domestic labor and content rules to leverage subsidies, notably in the US, have slowed the ramp-up of those projects. 

      The challenge is even greater when factoring in the demand for energy associated with the push to adopt generative AI. The energy associated with storing and curating data, and that needed to run the large language models, is enormous. However, there is hope. The tech sector is now scrambling to secure its own energy sources – one tech behemoth is building its own nuclear plant – while startups are looking for ways to better store renewable energy. This is in addition to efforts to increase the energy efficiency of large language models to reduce the stress on energy grids.

      Those shifts won’t come overnight, but when combined with a spike in energy prices, could provide a boost to the economic feasibility of renewables and accelerate their adoption. Ramping up the supply of energy will take time, but the lags could be less than we have seen in recent years.

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      Anatomy of an oil shock

      insight by KPMG Economics

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      Bhavesh Gandhi, Risk Management Leader, KPMG Middle East, South Asia, Caucasus and Central Asia (MESAC) region and Head of Financial Services
      Bhavesh Gandhi

      Risk Management Leader, KPMG MESAC and Head of Financial Services,

      KPMG in Kuwait

      Ali Abbas, Partner & Head of Risk Consulting, KPMG in Kuwait
      Ali Abbas

      Partner & Head of Risk Consulting

      KPMG in Kuwait

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