Oil Should Be Higher. Why Isn’t It?

Tresmark: Saudi Arabia’s oil story almost never took off

In 1938, after six disappointing wells, a telegram was on its way from California telling the exploration team to stop drilling. But chief geologist Max Steineke ignored the pessimism and told the crew at Dammam No. 7 to keep going.

Then, before the order to stop arrived, the well struck commercial oil.

That single decision changed Saudi Arabia and also the global economy

Why Hasn’t Oil Gone Higher?

The Middle East conflict has caused what the IEA calls the largest supply disruption in the history of the global oil market. More than 10mn bpd of Gulf production was shut in at one point, while global inventories have fallen by more than 500mn barrels since the conflict began.

And yet Brent futures peaked at around $126/bbl in April. During the latest escalation, they moved above $110 before falling back again.

The stress has often been more visible in physical barrels and refined products than in headline Brent, but given the scale of disruption, the benchmark itself has remained surprisingly restrained.

Why?

1. China Has Become the Swing Consume

China used to be the marginal buyer that could tighten an already tight oil market.

Sinopec now expects Chinese oil demand to fall by around 600k bpd this year, with gasoline demand down almost 9% and diesel demand down more than 11%. EV adoption, weaker industrial demand and greater energy efficiency are all contributing.

China also entered this crisis with substantial oil inventories, giving it room to draw stocks when prices are high and rebuild when prices become more attractive.

China has increasingly become the swing consumer.

2. Price Is Doing Its Job

Oil demand is still relatively inelastic in the short term. But consumers have more options today than during previous oil shocks. EVs and hybrids are more common, fuel efficiency has improved, alternative energy sources are larger and governments have strategic reserves.

And when prices stay high for long enough, people simply consume less.

The IEA has cut its 2026 global oil demand forecast by 2.5mn bpd. Demand fell 5.3mn bpd y/y during 2Q, the first quarterly decline since Covid.

High oil prices are beginning to solve part of the problem themselves.

The oil curve (futures) seems to expect the same. The market is desperate for your barrel today. It is much less worried about your barrel next year.

How Pakistan Has Absorbed the Shock

For Pakistan, Brent is only part of the energy bill. Diesel cracks, LNG, freight, insurance and the Dollar can make a $100 oil environment considerably more painful than Brent alone would suggest.
Pakistan has largely allowed higher fuel costs to reach consumers.

That is painful, but it changes behaviour. Higher pump prices reduce consumption and eventually imports, rather than shifting the entire burden onto the fiscal deficit or FX reserves.

India chose a different mix.

Its government kept regular retail prices relatively unchanged, with state oil companies absorbing substantial under-recoveries.

India has nearly $766bn in FX reserves, yet INR is undergoing intense pressure, foreign investors have withdrawn around $26bn from equities this year and a majority of economists expect RBI to raise rates by 25 bps next week.

RBI has also been actively intervening to support the Rupee. Its net forward Dollar liabilities increased by $63bn in August to a record $200bn.

Two neighbouring oil importers. Two very different adjustment mixes.

The IMF Question

Pakistan’s authorities reportedly expect inflation to average around 7.5% if oil returns towards $80, and around 8.2% if it remains near $100. They also expect inflation to moderate after December and argue that the current 11.5% policy rate remains appropriate.

Stable PKR helps contain imported inflation. Higher domestic fuel prices allow demand and imports to adjust.

The IMF, meanwhile, continues to emphasise a more market-based exchange rate. The authorities are reluctant to reopen the imported inflation pandora’s box.

But a market-based PKR does not automatically mean a weaker PKR.

If remittances remain strong, reserves continue improving, the current account stays manageable and Dollar demand remains contained, price discovery can still produce a stable currency.

Central banks intervene everywhere. RBI does it. Japan does it.

Rupee Outlook

The base case remains that PKR will not be the adjustment mechanism for this oil shock.

The adjustment is more likely to come through higher domestic fuel prices, lower consumption and imports and, if inflation remains persistent, monetary policy.

Exporters continuing to sell Dollars in the forward market appear to broadly share that view.

So What Are We Really Betting On?
That today’s energy shock is temporary.

The forward curve expects today’s shortage to ease. Pakistan’s inflation outlook also assumes oil eventually comes down.

Winter will be the next test.

If oil remains contained despite depleted inventories and continued disruption, it may tell us something important about today’s energy market.

The world still needs oil desperately. But perhaps high prices impact demand more quickly and sets off correction much faster than they once did.