China's inventories act as a buffer; if OECD inventories continue to fall, oil prices could reach $120/bbl in the third quarter

Overview

This report explains why oil prices remain below $100/bbl even as the US-Iran conflict approaches 100 days and oil flows through the Strait of Hormuz and the Red Sea have been disrupted. The core conclusion is that the market has absorbed the shock through multiple channels: Asia, especially China, has reduced imports and drawn down inventories, offshore floating storage has declined, supply from the Americas has increased, and OECD and US SPR inventories have been passively released. As a result, spot prices have not risen sharply immediately, but continued inventory declines imply oil price risks are skewed to the upside.

Core views

The report argues that the fact oil prices have not risen sufficiently does not mean supply-demand conditions are loose; rather, China and other inventory pools have temporarily absorbed Middle East supply disruptions. China's imports have fallen sharply while refinery runs remain resilient, implying commercial and strategic inventories are being drawn down; once China resumes purchasing and restocking, or if OECD inventories continue to fall rapidly, the global crude oil market could see a sharper price increase.

Analysis framework

The report uses a supply-demand balance decomposition method, breaking down the cumulative disruption of about 1.37bn barrels into declining Asian imports, reduced oil-on-water, OECD commercial inventory drawdowns, falling US SPR, increased supply from the Americas, and a residual balancing item, then combines tanker data, weekly inventory data, NBS data, and the historical inventory-oil price relationship to assess the oil price path.

Methodology notes

• Supply-Demand BalanceCumulative Disruption Bridge Analysis

  Break down Middle East oil flow disruptions into adjustment channels such as imports, inventories, offshore floating storage, and incremental supply.

  Using the cumulative supply disruption of about 1,371MMbbls from March 1 to May 31 as the starting point, the report deducts declining Asian imports, lower oil-on-water, OECD inventory declines, lower US SPR, and increased supply from the Americas item by item to identify the remaining unexplained balance.

• Inventory PricingOECD Inventory and Oil Price Correlation

  Use OECD commercial inventory levels to judge the fundamental anchor for oil prices.

  Current OECD inventories are about 2,740MMbbls, roughly consistent with current prices; if inventories continue to decline by about 1MMbbls/d, they could reach historical lows over the next 2-3 months and support oil prices rising to $120/bbl or higher.

• High-Frequency TrackingTanker Flows and Oil-on-Water Monitoring

  Measure physical market adjustment through tanker activity, Asian imports, and changes in oil-on-water.

  The report notes that tanker activity remains significantly below pre-conflict levels, while oil-on-water has fallen by 171MMbbls, showing that floating storage and in-transit inventories had been used to smooth short-term supply-demand gaps.

• China Inventory EstimationImplied Inventory vs. Refinery Run Comparison

  Infer China's inventory drawdown through imports, domestic production, and refinery throughput.

  China's crude oil imports have declined sharply while refinery operations remain relatively stable, indicating the supply gap has mainly been filled by commercial and strategic inventory drawdowns; the report estimates China's total inventories at about 1,541MMbbls.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Crude Oil

  Core asset

  Strengths

  Continued inventory declines, incomplete recovery from supply disruptions, and the historical inventory-oil price relationship support upside.

  Weaknesses

  Declining Asian imports, demand destruction, and increased supply from the Americas are temporarily restraining spot prices.

  Comparison

  Compared with expectations at the start of the conflict, the oil price response has been weak; compared with inventory trends, future price risks are skewed more to the upside.

  Risks

  A rapid end to the conflict, further weakening demand, or above-expected incremental supply could all reduce upside potential.

• CNOOC

  One of the top Asia-Pacific oil and gas picks

  Strengths

  Strong leverage to upstream oil prices, likely to benefit if oil prices rise.

  Weaknesses

  The excerpt does not disclose specific valuation or target price details.

  Comparison

  Listed as a top Outperform pick relative to other Asia-Pacific oil and gas stocks.

  Risks

  Failure of oil prices to rise, as well as policy and project execution risks, could affect performance.

• PetroChina

  One of the top Asia-Pacific oil and gas picks

  Strengths

  Has upstream oil and gas exposure and may benefit from higher oil prices and tighter supply-demand conditions.

  Weaknesses

  Its integrated business structure may dilute pure upstream oil price sensitivity.

  Comparison

  Listed alongside CNOOC and Santos as Asia-Pacific top picks.

  Risks

  Oil price declines, refining margin volatility, and policy factors.

• Santos

  One of the top Asia-Pacific oil and gas picks

  Strengths

  Its upstream energy exposure gives it the potential to benefit in a rising oil and gas price environment.

  Weaknesses

  The report excerpt does not provide detailed company-level valuation support.

  Comparison

  Along with CNOOC and PetroChina, it is a top Outperform pick.

  Risks

  Risks related to commodity prices, project execution, and regional supply changes.

• China Crude Oil Inventories

  Market buffer

  Strengths

  Large inventory scale can stabilize refinery run rates and domestic supply when imports decline.

  Weaknesses

  Inventory drawdowns cannot continue indefinitely, and official data lack transparency.

  Comparison

  Compared with markets such as Vietnam and South Korea that have smaller inventory buffers, China has stronger shock-absorption capacity.

  Risks

  If restocking is needed, it will intensify global crude procurement competition again and push prices higher.

• Asian Import-Dependent Economies

  Demand and inventory adjustment side

  Strengths

  China's reduced purchasing has freed up some cargoes, allowing imports by other Asian buyers to recover somewhat recently.

  Weaknesses

  Vietnam, South Korea, India, and Japan still face varying degrees of inventory drawdowns and import dependence.

  Comparison

  Vietnam and South Korea are more constrained, while China and Japan have relatively stronger inventory buffers.

  Risks

  If Middle East oil flows do not recover or China returns to the market, competition among Asian buyers could intensify again.

Key data

• Cumulative Supply DisruptionAbout 1,371MMbbls, about 14.9MMbbls/dFrom March 1 to May 31, mainly driven by disrupted oil flows related to the Strait of Hormuz and the Red Sea.
• Decline in Asian ImportsAbout 679MMbbls, about 7.4MMbbls/dThe largest adjustment item, accounting for about half of the total adjustment.
• Decline in Chinese ImportsAbout 5-6MMbbls/d, about a 40% year-on-year declineThe report says China accounted for the majority of the decline in Asian imports and eased supply competition for other Asian buyers.
• Decline in oil-on-waterAbout 171MMbbls, about 1.9MMbbls/dReflects drawdowns in floating storage and in-transit inventories used to buffer reduced Middle East exports.
• Decline in OECD Commercial InventoriesAbout 97MMbbls, about 1.1MMbbls/dThe inventory decline remains smaller than the total supply disruption, but is becoming a key anchor for further oil price gains.
• Incremental Supply from the AmericasAbout 250MMbbls, about 2.7MMbbls/dHigher supply from the Americas has partially offset Middle East oil flow losses.
• Decline in US SPRAbout 50MMbblsThe release of US strategic reserves is also one of the balancing items.
• Estimated Total China InventoriesAbout 1.4-1.5bn barrels, estimated by the report at about 1,541MMbblsCan support several months of buffering, but is only a temporary adjustment.
• Current OECD InventoriesAbout 2,740MMbblsThe report believes this inventory level roughly corresponds to current oil prices; if it continues to decline, oil prices may rise.
• Oil Price ScenarioCould reach $120/bbl or higher in the third quarterAssuming OECD inventories continue to decline by about 1MMbbls/d, or China re-enters the purchasing competition.

Impact & implications

In the short term, China's inventory drawdowns and compressed Asian demand explain why oil prices have not risen sharply; but such buffering cannot continue indefinitely. If the conflict persists, OECD inventories keep falling, or China resumes restocking, crude oil prices could rise much more sharply. On the equity side, the report continues to favor upstream oil and gas companies, especially CNOOC, PetroChina, and Santos; however, for Asian refining, chemicals, and consumption sectors dependent on imported crude, cost pressure could rise again.

Risks

• If the US-Iran conflict or regional disruptions end quickly, restored supply could weigh on the oil price upside scenario.
• China may continue to delay returning to the procurement market through inventory drawdowns, causing price increases to occur later than expected.
• Increased supply from the Americas or stronger-than-expected growth in other non-OPEC supply could continue to offset Middle East supply losses.
• If demand destruction expands, especially if Asian import demand declines further, the boost from lower inventories to prices could weaken.
• Transparency on China and non-OECD inventory data is limited, so implied inventory estimates may contain errors.
• SPR releases, sanctioned oil flows, and unobserved inventory changes may cause deviations in the supply-demand bridge results.

What to watch

• Whether OECD commercial inventories continue to decline by about 1MMbbls/d.
• Whether China's crude oil imports recover from low levels and whether it starts replenishing commercial and strategic inventories.
• Whether tanker activity in the Strait of Hormuz and the Red Sea returns to pre-conflict levels.
• Whether oil-on-water continues to recover or declines again.
• Weekly changes in US commercial inventories and SPR, especially whether the combined decline remains around 15MMbbls/week.
• Whether incremental supply from the Americas can continue to offset Middle East oil flow disruptions.
• Whether import recovery outside China in Asia will compete with China's restocking.