The Oil Market’s Billion-Barrel Problem

Summary

Podcast Summary: Thoughts on the Market – "The Oil Market’s Billion-Barrel Problem"

Date: July 29, 2026
Host: Andrew Sheats (A), Global Head of Fixed Income Research, Morgan Stanley
Guest: Marta Ratz (B), Head of Commodity Research, Morgan Stanley

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Overview

This episode unpacks the extraordinary volatility in the global oil markets, focusing on the dramatic swings in crude supply, refined product prices, and the "billion-barrel problem" of unaccounted-for oil inventories. Andrew Sheats and Marta Ratz break down the latest disruptions – from geopolitical choke points to refinery shutdowns – and debate how long the energy market can withstand these shocks before a larger crisis unfolds.

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Key Discussion Points

1. Recent Oil Market Volatility

Timestamps: 00:09–02:43

• Surge in volatility: The price of Brent fell to $70, driven by sudden availability as tankers stuck in the Strait of Hormuz during conflict were released, pushing physical oil temporarily into oversupply.
• Geopolitical disruptions: After a brief normalization, conflict resumed, leading to substantial reductions in flows through the Strait of Hormuz (down 80–90% from pre-conflict levels), and reigniting price rallies.
• Multiple choke points: Beyond Hormuz, issues at the Bab el-Mandeb Strait, CPC terminal (Russia), and tightening refining capacity add to a complex, volatile market landscape.
• Constructive but uncertain outlook: Disruptions lean toward supporting higher prices, but unpredictability makes forecasting difficult.

“Altogether, it’s been a tremendously volatile period. So on the whole, leaning towards the constructive side because there are so many disruptions in the system, but it’s a very hard one to call at the moment.”
— Marta Ratz [02:32]

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2. Beyond Hormuz: Other Major Disruptions

Timestamps: 02:43–06:25

• Bab el-Mandeb: A critical alternate route for Saudi oil exports, increasingly threatened by Houthi control and drone attacks, risking ~3.5 million barrels per day.
• CPC Terminal (Russia): Exports disrupted by Ukrainian attacks, with flows fluctuating and significant volumes (1.5–2 million barrels/day) at risk.
• Global refining crisis: Up to 60% of Russian refining capacity is offline, causing bans on gasoline and diesel exports from Russia. The price impact falls hardest on diesel, now $1200/ton ($150–$160/barrel equivalent).
• Physical tightness: Tight supply of diesel and other refined products is driving prices well above those of crude, causing economic strain.

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3. The Price of Diesel and Demand Destruction

Timestamps: 06:25–09:05

• Refined product crisis: End users feel the pinch through skyrocketing diesel costs, which have more direct economic consequences than benchmark crude prices.
• Thresholds for demand destruction: Historically, crude at $140–$150/barrel triggered demand curbs, but now products like diesel are leading the adjustment.
• Current situation: Diesel is trading at around $1230–$1240/ton. Further escalations to ~$1400/ton ($180–$190/barrel) would likely suppress demand.
• Who gets what: Refiners are capturing a disproportionate share of the price, squeezing margins for crude producers.

“The diesel price … is searching for this demand destruction price. … At the moment, we’re $1230, $1240, that sort of level. And so we are getting close. There is probably a little bit more to go, like another 5%, 10% … before you really hit some exceptionally high levels.”
— Marta Ratz [07:57]

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4. Economic and Growth Implications

Timestamps: 09:05–09:30

• Risks to growth: Elevated diesel prices risk curtailing transportation and industrial activity, particularly threatening fragile economic growth in Europe.

“Inherently that is, I think, a risk to growth, but especially risk to growth in Europe, where the starting point for growth is already pretty weak.”
— Andrew Sheats [09:14]

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5. The Billion-Barrel Inventory Mystery

Timestamps: 09:30–12:38

• Unaccounted oil: Despite over a 1.5 billion barrel supply loss since the conflict, observed global inventory draws are only about a third of that.
• "Billion-barrel problem": Large volume of oil is apparently held in “unobservable inventories”—possibly in supply chains, at end users, or in countries with limited data (e.g., China).
• Buffer exhaustion: While these invisible inventories have cushioned the market so far, the hosts warn that they will soon be depleted. If disruptions continue into late summer or fall, a serious crisis is likely as winter demand picks up.

“If you look at the cumulative amount of supply loss from the Middle East since this conflict, easily over 1.5 billion barrels ... yet the inventory draws that we can find in observable data, they are at best a third of that.... So there’s another billion barrels.... This system of unobservable inventories has to be way bigger.”
— Marta Ratz [10:20]

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Notable Quotes & Memorable Moments

• “What end users pay is not $85 per barrel for Brent crude oil, it’s $1,200 a tonne for diesel. And that is a very high price.”
  — Marta Ratz [03:45]

• “When supply is inherently scarce … the only way to balance sometimes is through demand destruction.”
  — Marta Ratz [07:12]

• “But because [unobservable inventories] are hard to observe, we don’t know when [they run out]. … By the end of the summer, we’re running on fumes. And so look, we’ve been able to patch this up, but it can’t go on forever.”
  — Marta Ratz [11:52]

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Segment Timestamps

• Volatility overview: 00:09–02:43
• Major market disruptions: 02:43–06:25
• Diesel price & demand destruction: 06:25–09:05
• Growth risks: 09:05–09:30
• Inventory mystery & future risks: 09:30–12:38

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Conclusion

The episode concludes with a warning that the confluence of global supply disruptions, elevated product prices, and untraceable inventories herald an unprecedented degree of uncertainty for oil markets. If current trends persist, the market’s hidden buffers will be exhausted, likely resulting in a sharp adjustment with severe economic and price consequences, particularly as demand builds into the winter.

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Transcript

[A]

Welcome to Thoughts on the Market. I'm Andrew Sheats, global head of fixed income research at Morgan Stanley.

[B]

And I'm Marta Ratz, head of Commodity research at Morgan Stanley.

[A]

Today, talking about the recent volatility and the direction ahead for oil. It's Wednesday, July 29th at 2pm in London. Martin, it's great to talk to you again. We haven't talked for a little while on this program, but oil is once again back in the headlines and it's moving around. So maybe to just jump right into things as you look at the lay of the land in global energy markets at the moment, what's been happening? What are you telling clients?

[B]

Okay, well, we've had a large amount of volatility over the last couple of weeks. If you roll the clock back sort of to the beginning of June, in the beginning of June, it started to become clear that already some more oil was leaking out of this tradermost and perhaps many of us anticipated at the time, but that data has been confirmed since then. And then, of course, in the middle of June, we got the Memorandum of Understanding. And after that, roughly 100, 150 million barrels a day or so that was behind the Strait of Moose got cleared.

[A]

These were tankers that were stuck there during the conflict all came out absolutely laden.

[B]

Tankers that were there had just basically turned into floating storage. For a good couple of months, they all cleared out. And that actually created a bit of a glut in the sense that all of a sudden the refiners of this world had a lot of crude to absorb. And we saw many indications of physical looseness in the physical differentials, calendar spreads, all sorts of indicators pointed that physically there was a lot of oil temporarily to be absorbed. And the spot price of Brent fell to 70 bucks. And that looked to be the new direction of travel. In principle, the world is not short of oil if you take the geopolitics out of it. So for a while it looked bearish. But then a new set of disruptions came and the military conflict restarted. And we've had 13 days of overnight bombing. And with that also, the flow through the Strait of Hormuz diminished again. And we are back in the last sort of week, 10 days to very, very low levels, the same levels we had in March. The flow through the Strait is not exactly zero, but it's sort of 2,3 million barrels a day, sort of down 80 to 90% of what it was before the conflict. And with that, prices have rallied. But on top of that, last week it looked like the military Activity could really scale up and for a couple of days the markets priced that in. But then we have other choke points to take into account now, not only Hormuz, but the Babel Mandeb, the CPC terminal, the issues in global RO refining, altogether, it's been a tremendously volatile period. So on the whole, leaning towards the constructive side because there are so many disruptions in the system, but it's a very hard one to call at the moment.

[A]

So, Martin, let's talk about those other disruptions besides just the Strait of Hormuz, because, yeah, it's not just the Strait of Hormuz anymore. We have issues in the Red Sea. You have ongoing issues with Russian energy infrastructure that's being attacked by Ukraine. Just what are these other factors that are out there and how much do they matter relative to, you know, how many ships are passing through the Strait of Hormuz?

[B]

Yeah, they matter a lot. And you can see that expressed in the price of refined products more than the price of crude. If you look at the main global benchmark for the price of diesel, which is arguably the ICE gas oil contract, which are diesel barges delivered in Rotterdam or in the wider Ara area, trading at about $1,200 a tonne, which is sort of $150, $160 per barrel, that's where you see the tightness. And so out of the total end user price, the refiners are capturing more at the moment than the crude suppliers. But what end users Pay is not $85 per barrel for Brent crude oil, it's $1,200 a tonne for diesel. And that is a very high price. Now, that is a result effectively of four major issues that the oil market has to deal with. One of them is Hormuz, as just discussed. But then we come to these other three. And these other three are the Bab El Mandeb, which is the strait on the other side of the Arabian Peninsula that provides entry and exit to the Red Sea. That strait has gained in importance because Saudi Arabia has been redirecting about 4 million barrels a day of crude oil supply that was previously exported via Hormuz, now through the east west pipeline to a terminal near a city called Yanbu, from where it is loaded and mostly sails down south through the Bab El Mandeb to refineries in Asia. The Bab El Mandab is a strait that is effectively controlled by the Houthis, which is an Iran aligned group that controls much of Yemen. And already in 24, earlier in 25, they've been very effective controlling tanker traffic through that strait. And in the last week or so, they have said that they will no longer allow Saudi tankers to sell out. And also that group has executed drone attacks on Saudi oil infrastructure near the Jizan refinery, near the Yanbu terminal, and overnight also the APKAIC facility, which is a large oil processing plant. So this whole Red Sea situation puts at risk something like an incremental 3.5 million barrels a day of crude. Then we've had to deal with issues at the CPC terminal, which is again, also a very large oil export terminal, about sort of 1.5 to 2 million barrels day of crude is exported from CPC, which is a terminal near the Russian city of Novorossiysk. Ukraine has been executing drone attacks on tankers that have been trying to load from the CPC terminal. Much of last week, the CPC terminal was out. It's on again, off again. It's a very disrupted flow in and of itself. A single terminal loading 1.5 to 2 million barrels a day is very, very large. So we care. And then the third issue that the oil market has been dealing with, and this also comes back to this issue about these refined product prices, is very severe tightness in the global refining system. That is an issue of some refineries can't export because they're behind the Strait of Hormuz again. So you can say, well, isn't that sort of the same problem? But nevertheless, it expresses it somewhere else. It's partly a problem of sort of the Chinese refinery system running very low, but it's recently mostly been driven by Ukrainian drone attacks on Russian refineries. And by now something like 60% of the Russian refining system is out. And with that, exports of refined products have declined very significantly. There is a gasoline export ban. There's a diesel export ban from Russia. Russia used to be a very large diesel exporter. That is now down to practically zero. And with that, refined product markets have rallied severely on top of the price of crude.

[A]

And I think that's interesting because when we think about the economic impact of oil, while, you know, the price of oil per barrel is often the most kind of visible marker that we have, it's often the refined product that we actually use. You know, a truck is running on diesel. It's not running on crude oil. And you know, that cost of diesel, of jet fuel, of gasoline, you know, that is the thing that can often really affect business margins and the ability to operate and move product around. So, I mean, just give a sense, like how, how much of Those diesel prices gone up, and how much further could they rise? If you're operating, you know, a trucking company in Europe.

[B]

Yeah. Look, when supply is inherently scarce, we often ask the question, what is the demand destruction price? Right. If you can't supply the stuff quick enough, the physical oil market, be it crude or refined product, must balance. There are a finite number of molecules in the system, and we can store them for a bit, we can take them out of storage. But when you take storage into account, molecules can't disappear out of nowhere, and they can't create it out of nowhere either. So the system must balance. And if you can't supply it quick enough, the only way to balance sometimes is through demand destruction. And then we ask the question, what is the price that effectively causes that to happen? And if you look historically, that is often expressed in crude, something like $140, $150 a barrel. We've seen that before. But those were occasions where refining was not an issue. And then crude needs to do the heavy lifting to drive prices higher. What we're having at the moment is that refined products need to do it. And so from experience earlier in the year, back in 2022, some other occasions, the price that destroys diesel demand is probably in the order of $1,400 a ton. In the diesel market, we use tons rather than barrels for historical reasons, just to make it easy. But it's about fourteen hundred dollars a ton, which is about sort of, you know, like $180, $190 per barrel, that really stops the diesel demand in its track. At the moment, we're 1230, 1240, that sort of level. And so we are getting close. There is probably a little bit more to go, like another 5%, 10%, that sort of thing before you really hit some exceptionally high levels. But the diesel price, I would argue, is doing exactly that. It's searching for this demand destruction price. It's just if you then take that sort of $160 diesel that we have at the moment, how much do the refiners get versus how much do the crude producers get? At the moment, the refiners are getting $65, $70 out of that, leaving comparatively little for the crude supplier. But the refined product price is the channel by which the economy is impacted and ultimately also by which demand is eroded.

[A]

When we're talking about demand destruction, we're talking about at what price does a trucking company not operate, does not drive as much, you know, does not, you know, we're talking about Less activity. And inherently that is, I think, a risk to growth, but especially risk to growth in Europe, where the starting point for growth is already pretty weak.

[B]

Yes. So we are watching as much how the Ukrainian drone attacks on Russian refineries are playing out as we are watching sort of the Strait of Hormuz.

[A]

Martin, the last thing I wanted to talk to you about is we've been talking about the Iran conflict since late February and we're sitting here in late July and it's clear that there was a small normalization in flows as you talked about, but we're back to a place where those flows are nowhere near normal. And I think the question on everybody's mind is how much longer can this go on before there's a much larger shock to energy prices? Now, again you mentioned we're already seeing some of that shock to diesel, but a much bigger disruption. What's your current thinking on how much Runway the energy system still has?

[B]

Yeah, it's an excellent question and it's turned out to be fiendishly hard to answer. My gut feel, based on how the data is behaving, based on what we know from history, if this lasts another sort of month or two, three, then it's hard to argue that by then the buffers in the system will not have been completely exhausted. The reason why I think oil analysts have lost a degree of confidence in forecasting this accurately is that there's a lot of unexplained oil that does require some explanation. If you look at the cumulative amount of supply loss from the Middle east since this conflict, easily over 1.5 billion barrels, 1.5 billion barrels in 150 days is an enormous amount. And yet the inventory draws that we can find in observable data, they are at best a third of that, maybe half a billion barrels. And so there's another billion barrels. We say yeah, we had that last year, but we don't have this this year where how did we solve that billion barrel problem? And you can say, well, we were a bit oversupplied going into it and a few other things. But you sort of have to conclude, and I think this is also talking to clients and investors, other market participants. I think this is sort of collectively we're discovering this is that this system of unobservable inventories has to be way bigger. That is either inventories like in the supply chain inventories at customers end or in countries where we generally have little data anyway, like in China. And so the system has been behaving as if already in 24 and 25, actually, we were putting a lot of oil into these in storages that are hard to observe because in that period we had the opposite problem. We were forecasting large inventory builds and we couldn't find them all. And now we're forecasting large draws and we haven't been able to find them all. And so the system has been behaving as the unobservable part of the inventories are way larger, but at some point they also run out. But because they're hard to observe, we don't know when. And I would guess if we're getting towards the end of the summer, by August, September, and we're still in this situation, yeah, then we're going into the winter. German households objectively have little storage of heating oil and they need to be rebuilt. And there are a few examples where we do know what customers are doing with their inventories and they point to a picture where, yeah, by the end of the summer we're running on fumes. And so look, we've been able to patch this up, but it can't go on forever.

[A]

Well, Martin, always a pleasure to catch up with you and talk energy markets. Nice to talk to you and thank you for listening. If you enjoy thoughts of the market, please take a moment to rate and review us and please share with a friend or colleague today.

[C]

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