Oil prices have pulled back sharply, falling to lows not seen in three months. This decline coincides with a pending memorandum of understanding between the United States and Iran, with a formal signing potentially set for Friday that could reopen the Strait of Hormuz. The central question is whether markets have correctly priced this development — or whether they are getting ahead of themselves by assuming a smooth, frictionless reopening that has not yet materialized.
Is the Market Pricing Oil Correctly?
One view holds that the market has actually done a reasonably good job of pricing oil where it currently sits, around $80 a barrel. The logic rests on a probabilistic, expected-value framework. The base case anticipates that the Strait of Hormuz will be opened, large volumes of barrels will return to the market, and conditions will gradually normalize. However, this optimism is tempered by an important countervailing fact: inventories have declined substantially. Global crude oil inventories and global refined product inventories are both down significantly.
Weighing these forces produces a roughly balanced outcome. There is approximately a 50% probability that inventories continue to deplete, and approximately a 50% probability that the market returns to a more normal supply-demand environment. Running that expected-value calculation lands oil at about $80 — essentially where prices are trading right now.
The 50/50 Scenario: $60 Versus $100
This balanced outlook can be broken into two distinct, equally weighted scenarios.
The $100 case. If oil inventories continue to fall, prices fail to move rapidly back toward equilibrium, and the market does not return to a healthy supply-demand balance, then continued inventory draws would push prices progressively higher. The longer this dynamic persists, the greater the cumulative pressure — and the duration of such conditions could carry oil all the way to $100 a barrel.
The $60 case. The opposite outcome involves a return to what might loosely be called "normal," though it is genuinely uncertain whether a true normal exists in the oil market. The relevant reference point is the pre-war environment, in which supply and demand were more balanced and the market was in fact oversupplied. A return to those conditions could move oil down closer to $60 a barrel.
With roughly 50% odds assigned to each scenario, the quick expected-value calculation again resolves to about $80 — consistent with current prices.
How Much Risk Premium Is Warranted?
A key issue heading into the potential Friday signing is how much risk premium should be priced into crude. The answer is that a $5 to $10 risk premium from current levels is very warranted, and this stems directly from the fragility of the negotiations.
Several sticking points remain. Negotiators must hammer out the details of unfreezing Iranian funds — specifically the timing and the actual release of those funds. They must also resolve a tolling arrangement: the Iranian regime appears to want to charge a fee for passage across the Strait of Hormuz, while the Trump administration has repeatedly insisted there will be no tolls or fees. This is a genuine point of contention and a real source of concern over potential hiccups in future negotiations.
The directional logic is straightforward. Any indication that the strait remains closed beyond the Friday opening date and formal signing implies that supplies will continue to be challenged. The conflict has been expected to drive prices higher for months; what remains uncertain is simply the magnitude of the disruption and the duration of the strait's closure. A longer outage supports higher pricing.
Why Reopening Will Not Normalize Markets Overnight
Even if the strait reopens immediately, markets will not snap back to normal at the flip of a switch. The restoration of physical flows is a gradual, multi-stage process with significant lags.
If a full reopening of the Strait of Hormuz occurs immediately, it would likely take several weeks just to restore tanker traffic to 50% of pre-war levels. A full restoration of transit activity across the strait would probably take several months. On top of that, once exports resume, it typically takes 40 to 60 days for tanker cargoes to reach their import-market destinations. Taken together, full volume restoration reaching import markets would not occur until roughly the September time frame.
During that interim period, inventories are fully expected to continue drawing down. Approximately one million barrels a day are currently coming out of the U.S. Strategic Petroleum Reserve, and volumes are also being drawn from foreign strategic petroleum reserves. These draws will continue for several months until full volume restoration is achieved. This points to a very tight supply situation. Compounding the tightness, demand has remained very robust and very strong throughout. Consequently, any hiccup — any derailing of the negotiation process, or a prolonged discussion over the arrangements for resuming transit through the strait — will send prices higher.
Current Price Snapshot
At the time of this discussion, U.S. oil was trading at $76.68 and Brent crude at $79.61.
Key Questions Raised and Answered
Is the market getting ahead of itself by pricing in a smooth reopening that hasn't happened yet? No — the market has probably priced oil fairly well at around $80, because while a reopening is anticipated, the offsetting reality of heavily depleted inventories balances the outlook on roughly 50/50 odds.
How much risk premium should be priced into crude before a potential Friday signing? A $5 to $10 risk premium from current levels is very warranted, given the real risk of negotiation hiccups over fund releases and the disputed tolling fee.
Under what scenarios does oil reach $60 versus $100? Oil reaches $100 if inventories keep falling and the market fails to return to supply-demand equilibrium for a sustained duration; it falls toward $60 if conditions revert to the more balanced, oversupplied pre-war environment.
If the strait reopens, how long before global market disruption ends? It would take several weeks to reach 50% of pre-war tanker traffic, several months for full transit restoration, and — accounting for the 40-to-60-day transit time for cargoes to reach import markets — full volume restoration would not arrive until roughly September, with inventories drawing down throughout that interim.
