With the Iran war approaching the 6-month mark, Americans are feeling the pain at the pump with the national average price for a gallon of gas north of $4. Oil briefly topped $120 per barrel early in the war and has since retreated to around $90 but is still 30% above the pre-war level.
This is hardly surprising, as the Iranian response to the U.S.-Israeli attack was to close the narrow but critical waterway through which 20% of the world’s oil passes. What is surprising is why the price isn’t much higher.
At the outset of the conflict, most oil analysts expected crude prices to shoot up to $150 or even $200 per barrel. After all, one fifth of the global supply was abruptly halted. But the market response, at least so far, has been less dramatic than anticipated for a variety of interesting reasons.
We’re more energy efficient. Compared with the energy crises of the past, the U.S. is far more efficient at using energy. For one thing, America is much more of a service economy today which uses less energy than manufacturing or mineral extraction. Our homes and vehicles are stingier today thanks to technological advancements and regulatory standards. The average 1975 model car got 13 miles per gallon; today the average is 28. The amount of oil needed to produce $1 of GDP has declined by nearly 70% since the embargoes of the 1970s and the share of the average household budget devoted to energy expenses has fallen by 60% since 1980.
Pre-war overproduction. Before the attack on Iran, the world was awash in oil. Global production exceeded consumption by 3 to 4 million barrels per day, bulking up inventories and driving prices lower. The American shale revolution is a primary contributor to the surge in supply, as the U.S. became the world’s largest oil producer a decade ago.
Brent crude, the global standard, fell to $60 per barrel in January, and many analysts feared a glut was developing. These stockpiles provided a critical supply cushion when Persian Gulf shipments were curtailed.
Alternate routes. Since the outbreak of the war, oil producers have raced to find ways to bypass the strait. For instance, Saudi Arabia has a pipeline from the from the Persian Gulf to the Red Sea, and the United Arab Emirates operates a pipeline to the Gulf of Oman. These two alternate routes have replaced about a quarter of the stranded supply.
Constricted refining capacity. No one fills the gas tank with crude oil. It needs to be processed into gasoline, diesel, and jet fuel, and the capacity to refine oil into other products is currently constrained. About 5% of global refining capacity is offline due to damage from the wars in Iran and Ukraine as well as Chinese and Russian export restrictions. Fewer refineries operating also means less demand for the crude to refine.
China to the rescue. Perhaps the biggest reason that prices are not even higher is the somewhat mysterious response of China to the supply crunch.
China is the world’s largest oil importer by far. But since the outbreak of the war, it has surprisingly slashed its purchases by half to around 5.5 million barrels per day, offsetting another quarter of the Hormuz constriction. The Chinese economy is certainly slowing, but nowhere near enough to explain the drastic reduction in imports.
For well over a year, Beijing has been building a massive strategic reserve inventory of crude oil. Its aggressive purchases during 2025 are responsible for soaking up much of the excess supply and keeping the price of crude above $50.
Official government data is unreliable, but satellite imagery suggests that China’s total stock is around 1.4 billion barrels. For comparison, the U.S. strategic reserve has fallen below 300 million barrels for the first time ever since it was created in the 1980s.
Furthermore, the visible above ground storage stocks are not being depleted, which suggests that there may be even more hidden reserve capacity underground supplying domestic needs. China appears to be living off its massive reserves.
Why Beijing is doing this is a puzzle, and no one saw it coming. China may be helping to hold oil prices down to assist the other Asian economies that purchase its exports. It has also been suggested that Xi Jinping is creating leverage to use against the United States in the future. A rapid return to China’s previous import level would add another $30 per barrel to the global oil price. In any event, this curious behavior is the major reason that gas is $4 a gallon and not $6. Yet.
With every day the war drags on and the strait remains closed, the world’s crude inventory cushion is diminishing. If the perception takes hold that we are trapped in another Middle East quagmire with no apparent exit strategy, the risk of $150 oil increases along with the odds of global recession.
For much of the war, oil prices fell with every promise by the administration of an impending Iranian surrender, only to surge again when a deal proves elusive. Secretary of Defense Pete Hegseth repeatedly assured Americans that the conflict would result in a quick surrender and that Iran’s ability to fight had been obliterated. Now nearly 6 months on, traders are learning to ignore the jawboning. On Tuesday, for example, the President said the strait was “open and operating”. That same day, just 6 ships transited the passage compared with an average 130 per day before the war. Only one of those vessels was a tanker, carrying a cargo of asphalt. Good news at least for I-75 construction. Mr. Trump’s first defense secretary James Mattis, a man of fewer but weightier words, famously said “the enemy gets a vote.”
A confluence of workarounds, excess reserves, efficiency improvements and the expectation of an end to hostilities has helped mitigate some of the pain at the pump and the grocery store. But not forever.