Oils next move hinges on three variables

Oil has rallied hard, but the story is more nuanced than simply "war equals higher prices." Technicals suggest the move is becoming stretched, while JPMorgan argues the market has remained balanced through weaker demand rather than collapsing supply. The key question now is whether that adjustment can continue if disruptions persist.

The surge in oil has pushed RSI into deeply overbought territory. While the Middle East situation remains highly fluid, the market looks due for at least a short-term pause. Whether that pause turns into another leg higher depends largely on the fundamental backdrop outlined below.

Oil volatility has picked up in recent weeks, but remains well below the levels seen during the March panic despite the sharp rally in spot prices. The key difference is that this move has been a steady grind higher rather than a series of panic-driven spikes, something that tends to keep implied volatility more contained.

The latest escalation in the Middle East has pushed Brent nearly 40% higher in July, on track for its strongest monthly gain since March, while US gasoline prices have climbed back above $4 per gallon. Yet at around $100/bbl, Brent is only about $13 above JPMorgan's estimated fair value, suggesting the market is pricing in only a modest geopolitical risk premium. That is notable given tanker traffic through the Strait of Hormuz remains at just 50% of pre-war levels, far below JPMorgan's assumption of a recovery toward roughly 73%, with even rerouted pipeline flows facing growing disruption risks.

Despite severe disruptions to shipping through the Bab el-Mandeb and Strait of Hormuz, oil prices remain relatively subdued. Partly, markets appear to be pricing in a negotiated resolution rather than a prolonged conflict. More importantly, the market has rebalanced through weaker demand rather than inventory draws. Since the conflict began, roughly 11.1 mbd of supply has been lost, but demand has fallen by about 5.1 mbd, offsetting nearly half of that loss, while inventory releases contributed only 3.6 mbd. Because the adjustment has come primarily from weaker consumption rather than depleted inventories, oil prices have remained lower than many expected.

The magnitude of the estimated demand loss has raised questions, especially with the global economy still growing above trend. While hidden inventory draws, particularly in China and other countries with limited reporting, could explain part of the gap, JPMorgan believes most of the adjustment reflects genuine demand losses caused by physical supply shortages rather than higher prices. The burden fell overwhelmingly on non-OECD countries and China, where limited access to alternative supplies forced fuel rationing and petrochemical shutdowns. OECD demand proved far more resilient, with US oil consumption even rising during the FIFA World Cup. China ultimately absorbed most of the shock, cutting oil imports by roughly 5 million barrels, while the US and Japan supplemented the adjustment through large strategic inventory releases.

JPMorgan argues the current disruptions are not yet enough to create a severe global supply shortage. Even if flows through Hormuz and the Red Sea decline by another 4 mbd, the market could remain balanced provided demand, especially in China, stays depressed. China is expected to sustain crude imports roughly 4 mbd below normal for another three months, continuing to cushion the market. Over time, however, inventories would need to shoulder a much larger burden. A three-month extension of the conflict would require nearly 500 million additional barrels of inventory releases on top of the roughly 500 million barrels already drawn down. JPMorgan warns the US has limited capacity to keep supplying that buffer, meaning Europe, Japan and South Korea would increasingly need to release inventories, or global demand would have to weaken further.