Oil Markets in Five Pictures: What’s Driving Prices Now?

Oil prices have remained elevated despite a significant recovery in Middle East energy flows, raising an important question for investors: to what extent do current oil prices reflect underlying physical tightness versus a geopolitical risk premium?

The physical market provides some justification for higher prices, but the broader picture is more nuanced. Refined-product balances are tighter than crude balances, global economic activity remains relatively resilient, inventories have been drawn down, and supply remains vulnerable to renewed disruption. At the same time, global supply has recovered substantially as energy flows through the Persian Gulf have largely normalized, and the global oil supply-demand balance is still on track to return to surplus in early 2027.

This suggests that a meaningful portion of elevated prices may reflect a premium for geopolitical uncertainty rather than underlying physical shortages. For investors, that distinction matters. A risk premium can persist while uncertainty remains elevated — but it can also dissipate quickly in response to credible signs of de-escalation.

Crude oil prices have risen roughly 30% from the lows reached in late June and early July following the breakdown of the Islamabad Memorandum of Understanding between the U.S. and Iran. Since September, oil prices have averaged $95 per barrel, below their 2026 highs but still above pre-war levels.

Refined-product prices tell a somewhat different story (Exhibit 1). Gasoline prices remain close to their post-war highs, while diesel prices face even greater pressure, approaching record levels. Tighter product balances relative to crude explain this divergence. Refined-product supply has been slower to recover because of refinery outages and disruptions. Demand has remained relatively resilient, with recent measures exceeding five-year averages. Diesel demand is particularly inelastic given its close ties to economic activity and recent support from government measures.

One notable development in energy markets has been the recovery in Middle East energy flows despite the ongoing conflict. Persian Gulf exports of crude and refined products have recovered to approximately 23 million barrels per day (mb/d), compared with a 2025 average of 24.6 mb/d (Exhibit 2). This is notable given that Iranian exports — roughly 2 mb/d before the war — have effectively disappeared, while flows through the Strait of Hormuz remain below pre-war levels. Increased flows through the Red Sea and Gulf of Oman, combined with the rapid restoration of East-West pipeline capacity, have largely offset the reduction in volumes transiting the Strait of Hormuz.

Overall crude exports have surpassed 2025 levels, whereas refined-product exports remain roughly 30% below their 2025 average. This divergence is consistent with the tighter refined-product market described above and helps explain why diesel and other refined products remain under greater pressure than crude. 

The crude market has therefore demonstrated considerable capacity to reroute supply and restore production. Global oil supply, led by Gulf producers, increased by approximately 2.5 mb/d in September to 102.3 mb/d, compared with 96.4 mb/d in the second quarter of 2026.

In this scenario where supply has recovered, the other explanation for elevated crude prices would be stronger-than-expected demand. However, the evidence for this is less compelling. 

China has been an important source of demand weakness, weighing on oil prices since the onset of war. Since June, Chinese oil imports have recovered by roughly 2 mb/d but remain well below the levels seen from 2023 through 2025 (Exhibit 3). Chinese refinery runs also remain subdued. The recent Trump-XI summit, which resulted in an extension of the U.S.-China trade truce, suggests China could continue to cooperate and restrain its oil imports.

Elsewhere, demand conditions in the U.S. and Europe — two of the world’s largest oil-importing regions — have been relatively resilient. Nevertheless, decomposition analysis suggests that supply-side developments remain more influential than demand-side factors when explaining recent price movements. 

Alongside recovering supply, global crude balances are still expected to remain in deficit through year-end, although the market has loosened considerably and is on track to return to surplus in 2027. 

With supply recovering and demand providing only limited support, a geopolitical risk premium appears to be an important factor sustaining elevated oil prices.

Emergency reserve releases have also played an important role in moderating price increases since the onset of the war. In March, the International Energy Agency authorized the release of approximately 400 million barrels from emergency reserves, with the U.S. providing the largest contribution. These releases have helped cushion the initial supply disruption and reduced the need for higher crude prices to curb demand. 

However, the effectiveness of this buffer is diminishing. U.S. Strategic Petroleum Reserve (SPR) withdrawals are slowing, while global commercial inventories are approaching historically low levels (Exhibit 4). Although energy flows are normalizing, the inventory cushion available to absorb another disruption has narrowed considerably. This helps explain why the market continues to price a premium into crude oil even as physical flows recover.

Markets also appear to be assigning a meaningful probability to the possibility that the recovery in energy flows will prove temporary. Attacks on commercial shipping remain a concern. While President Trump has not ruled out military strikes, he has indicated they would not occur before the November midterm elections. Market-based indicators also suggest that investors anticipate an extended period of geopolitical uncertainty. Since August, prediction-market odds of a U.S.-Iran nuclear agreement before 2027 have remained below 20%, while markets have assigned a greater-than-even probability to U.S. military action before December. 

Expectations of a prolonged conflict may therefore be contributing to demand for inflation protection, with investors using oil as a hedge against potential future disruptions. This dynamic is also reflected in volatility. The CBOE crude oil volatility index remains elevated relative to pre-war levels, although it has declined substantially from the extreme readings recorded in March and April. 

Persistently high oil prices present two important stagflationary risks: greater pass-through to consumer inflation and weaker demand as higher energy costs weigh on economic activity. So far, however, the pass-through to consumers has been limited (Exhibit 5), while domestic demand has remained resilient. Estimates suggest that higher energy prices will add only a modest 20 basis points to core inflation (excluding food and energy), primarily through higher airfares. Meanwhile, consumer spending is on track for another robust quarter with an annualized growth of 3% in the third quarter.

For the Federal Reserve (the Fed), the greater concern is the potential for more broad-based inflation, especially if demand conditions stay resilient. Elevated diesel prices pose a particular risk, as diesel accounts for roughly 70% of oil inputs used by firms. Producer prices are therefore more sensitive to changes in diesel prices than consumer prices are, whereas the impact on consumer prices is less certain and likely to remain limited in the short term. Goods prices are most exposed, but account for only a quarter of core PCE, the Fed’s preferred inflation gauge. We continue to expect the fading effect of tariffs to be the dominant influence on goods inflation. Nonetheless, elevated energy prices are likely to reinforce the Fed’s bias toward further rate hikes, provided demand stays resilient.

Conclusion 

Physical supply-demand fundamentals alone do not fully explain why crude oil prices have remained elevated above $90 per barrel. Markets are likely attaching a significant geopolitical risk premium. This suggests that if the conflict persists, that premium could remain elevated for an extended period. Conversely, credible signs of meaningful de-escalation could prompt a rapid compression of the risk premium, even before physical market conditions adjust.

At the same time, underlying physical market conditions remain vulnerable. Crude balances are still in deficit, refined-product balances are tighter, inventories are low, and the ongoing conflict leaves supply exposed to renewed disruption. A prolonged conflict could further increase the market’s vulnerability to supply disruptions. Persistently elevated gasoline and diesel prices also pose growing inflation risks and remain an important reason we expect additional rate hikes. Refined product markets are also likely to take longer to adjust following any conflict resolution. We remain overweight equities with an underweight to consumer discretionary given continued pressure on the consumer. We will continue to monitor the evolution of the conflict and implications for energy markets, inflation, and monetary policy.