Geography, Geopolitics, and Gamesmanship Leave Little Room for Error in Energy Markets

The Persian Gulf remains the epicenter

The path of hostilities in the Persian Gulf remains first on the list of concerns. After a brief, constrained reopening of the Strait of Hormuz following the ceasefire, shipping through the strait is again at a near standstill. Without shipping, production is effectively limited to what can be consumed locally or piped across Saudi Arabia to the Red Sea or across the United Arab Emirates into the Gulf of Oman.

The U.S. maintains a blockade on Iranian exports, while Iran is asserting control of the strait as the new status quo – whether for economic rent or strategic defense. Cumulative oil supply losses to date exceed a billion barrels, now the largest net loss of energy supply in history. With dozens of ships attacked, insurance costs have surged and the pool of owners willing to risk crews and hulls in the strait has shrunk. The situation is fluid, but supply from a region that provides nearly 20% of global oil must eventually normalize, or the global economy will have to adjust. (All data are from the International Energy Agency (IEA) with PIMCO calculations.)

A second front in the Red Sea

Saudi Arabia’s rerouting of 4 million to 5 million barrels per day to the Red Sea in response to the Strait of Hormuz closures (according to Kpler) has been a critical lifeline for the oil market. Thus, the Houthis’ renewed attacks on Saudi shipping and infrastructure in the Red Sea escalate the risk that Saudi oil supplies can’t make their way out of the Middle East.

History shows the Houthis can meaningfully disrupt traffic through the Red Sea’s Bab el-Mandeb Strait to the south, with less impact on northern flows through the Suez Canal to the Mediterranean. If the issue is largely confined to Saudi vessels through this strait, while other ships pass, the impact is more logistical than fundamental. Asia’s dependence on Saudi barrels moving through Bab el-Mandeb could be reduced by rerouting ships north. That is taxing, but not a net supply loss.

The calculus changes considerably if the Houthis continue to strike Saudi export infrastructure, prevent ships from docking, meaningfully block all traffic through Bab el-Mandeb, or hit the pipelines running from the eastern producing basins to the Red Sea. The situation remains tenuous.

Russia-Ukraine attacks tighten the product market

The third critical geography is the escalating Ukrainian campaign against Russian shipping, refining, and now export ports. The reach and efficacy of these strikes deep into Russia have been significant, and the costs to the oil market are adding up. Russian refining has been impaired for months, dropping processing to its lowest level in over 20 years, according to the IEA. Russia, normally a major exporter of refined products – particularly diesel – has not only cut exports but also been seen buying gasoline cargoes to replace lost domestic supply. Combined with reduced product exports from the Middle East, this has driven diesel, jet fuel, and gasoline to record premiums over crude.

More recently, Ukraine has stepped up attacks in the Sea of Azov and Black Sea, disrupting both energy and critical grain flows. Strikes on the Port of Novorossiysk, where several ships were hit by unmanned surface vessels (USVs), have curtailed exports of critical Kazakh oil. The port had been loading roughly 2% of global supply before the attacks (according to the IEA), which would be a non-trivial loss even in the best of times.

The squeeze is in products and natural gas, not just crude

The problem facing the global economy is not limited to crude oil. Refined products – petrol, diesel, and jet fuel – sit at record price premiums to crude, reflecting genuine supply chain constraints. Even with crude nearly 30% off its year-to-date peak, refined products as of this writing are within a few percentage points of year-to-date highs, pushing U.S. retail gasoline above $4/gallon and diesel above $5/gallon (according to Bloomberg and the American Automobile Association).

Higher prices for refined products can significantly damage activity, because roughly two-thirds of world oil output goes to transportation, and Middle Eastern crude is refined disproportionately into the middle distillates (diesel, jet fuel, shipping fuel) on which Asia, Africa, and industry depend. Shortages translate quickly into reduced deliveries, stranded cargoes, and broader supply chain and food price pressures via diesel and fertilizer.

The Persian Gulf is also a critical supplier of liquefied natural gas (LNG), and global gas prices as of this writing have climbed to their highest since Russia’s invasion of Ukraine – a particular problem because, outside the U.S., inventories are on track to enter winter with the thinnest storage coverage in over a decade.

The buffers are largely exhausted

Crucially, many of the shock absorbers that cushioned the early stages of the U.S.–Iran conflict are now depleted. Strategic petroleum reserves globally have already released some 300 million barrels – offsetting almost a third of the global supply loss – dropping U.S. reserves to their lowest since 1983, when stocks of the Organization for Economic Co-operation and Development were being deliberately built after the oil price shocks of the 1970s (data according to the IEA). Commercial inventories have also drawn down, taking stocks of key refined products to multi-decade lows.

System flexibility is far lower today than earlier in the year, and, unlike then, we are heading into harvest, pre-holiday stockpiling, and the tail of the summer travel season. The room for error is minute.

The China wildcard

One major surprise has been how far and fast China cut crude imports. The world’s largest importer nearly halved purchases through a mix of demand reduction, inventory withdrawals, and lower product exports – the last of which only worsened the global product shortage. Drawing on inventories built up in prior years, China has bought itself flexibility, but the open question is how long it will keep imports constrained. Never has a demand source of this scale adjusted by this magnitude.

The timing and pace of the demand recovery and ultimate restocking complicate views on second half of 2026 and 2027 balances. Should China maintain its current import levels, crude oil prices will likely face less upward pressure. Should China re-enter the market and begin restocking, oil supplies would need to ramp up to match, or shortages will emerge outside of China.

What it means for the global economy

This is, at its core, a stagflationary supply shock: It lifts headline inflation broadly, while weighing on activity. Higher real energy prices act as a tax on consumers of oil and energy products, while a large global disruption in oil supplies would necessitate lower demand. How smoothly that adjustment happens is a key question for markets. As we learned during the pandemic, seemingly small disruptions can reverberate through global supply chains.

Regionally, the growth hit falls hardest on net energy importers – Europe, the U.K., Japan, and much of Asia. What is unique to this episode is how the AI-driven surge in demand for energy and for energy-intensive products (memory and chips) could compound the market disruption.

Monetary and fiscal tools have limited ability to offset a sustained energy shock; central banks are constrained by inflation and the need to keep expectations anchored, while government policies – including price caps and similar demand supports – can be counterproductive, since in a genuine shortfall prices must rise enough to clear the market, and blunting that mechanism in one region only pushes the global price higher.

Thus far, financial conditions haven’t tightened very much, as higher rates have been cushioned by a lower equity risk premium. But this is precisely why markets remain vulnerable to a sharp, nonlinear tightening if pricing shifts toward a more prolonged disruption.

Bottom line

Earlier in our careers, oil supply balances swinging perhaps a few hundred thousand barrels a day were enough to move prices and shape conclusions. Today, the number of line items carrying several-million-barrel uncertainty is surreal, with meaningful – and heavily upside-skewed – price implications if supply does not normalize.

It is precisely these pricing pressures that many are counting on to push the U.S. toward a resolution of the Iran conflict. However, given the lack of trust and the competing, often non-intersecting interests of the parties, a solution is hard to bank on.

For investors, hedging commodity risk through a commodity index may make sense. Commodity indices can help diversify portfolio risk and potentially enhance returns. And given the attractive carry on commodity indices today – e.g., 6% on the Bloomberg Commodity Index as of 23 July 2026 – the hurdle investors must clear to consider holding that exposure is meaningfully lower.

For more insights into commodity markets, listen to PIMCO’s Accrued Interest podcast discussion with Greg Sharenow on Apple and Spotify.

Disclosures

All investments contain risk and may lose value.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. | Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517, 11 Baker Street, London W1U 3AH, United Kingdom) is authorised and regulated by the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. Since PIMCO Europe Ltd services and products are provided exclusively to professional clients, the appropriateness of such is always affirmed. | PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany) is authorized and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 15 of the German Securities Institutions Act (WpIG). | PIMCO Europe GmbH Italian Branch (Company No. 10005170963, Via Turati nn. 25/27 (angolo via Cavalieri n. 4) 20121 Milano, Italy), PIMCO Europe GmbH Irish Branch (Company No. 909462, 57B Harcourt Street Dublin D02 F721, Ireland), PIMCO Europe GmbH UK Branch (Company No. FC037712, 11 Baker Street, London W1U 3AH, UK), PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E, Paseo de la Castellana 43, Oficina 05-111, 28046 Madrid, Spain), PIMCO Europe GmbH French Branch (Company No. 918745621 R.C.S. Paris, 50–52 Boulevard Haussmann, 75009 Paris, France) and PIMCO Europe GmbH (DIFC Branch) (Company No. 9613, Index Tower Floor 10, unit 1001 Dubai International Financial Centre, Dubai, United Arab Emirates) are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) (Giovanni Battista Martini, 3 - 00198 Rome) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland (New Wapping Street, North Wall Quay, Dublin 1 D01 F7X3) in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN); (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) (Edison, 4, 28006 Madrid) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Title V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively, (5) French Branch: ACPR/Banque de France (4 Place de Budapest, CS 92459, 75436 Paris Cedex 09) in accordance with Art. 35 of Directive 2014/65/EU on markets in financial instruments and under the surveillance of ACPR and AMF and (6) DIFC Branch: Regulated by the Dubai Financial Services Authority ("DFSA") (Level 13, West Wing, The Gate, DIFC) in accordance with Art. 48 of the Regulatory Law 2004. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. According to Art. 56 of Regulation (EU) 565/2017, an investment company is entitled to assume that professional clients possess the necessary knowledge and experience to understand the risks associated with the relevant investment services or transactions. Since PIMCO Europe GMBH services and products are provided exclusively to professional clients, the appropriateness of such is always affirmed. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2, Brandschenkestrasse 41 Zurich 8002, Switzerland). According to the Swiss Collective Investment Schemes Act of 23 June 2006 (“CISA”), an investment company is entitled to assume that professional clients possess the necessary knowledge and experience to understand the risks associated with the relevant investment services or transactions. Since PIMCO (Schweiz) GmbH services and products are provided exclusively to professional clients, the appropriateness of such is always affirmed. The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (8 Marina View, #30-01, Asia Square Tower 1, Singapore 018960, Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited (Suite 2201, 22nd Floor, Two International Finance Centre, No. 8 Finance Street, Central, Hong Kong) is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. PIMCO Asia Limited is registered as a cross-border discretionary investment manager with the Financial Supervisory Commission of Korea (Registration No. 08-02-307). The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Investment Management (Shanghai) Limited. Office address: Suite 7204, Shanghai Tower, 479 Lujiazui Ring Road, Pudong, Shanghai 200120, China (Unified social credit code: 91310115MA1K41MU72) is registered with Asset Management Association of China as Private Fund Manager (Registration No. P1071502, Type: Other). | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862. This publication has been prepared without taking into account the objectives, financial situation or needs of investors. Before making an investment decision, investors should obtain professional advice and consider whether the information contained herein is appropriate having regard to their objectives, financial situation and needs. To the extent it involves Pacific Investment Management Co LLC (PIMCO LLC) providing financial services to wholesale clients, PIMCO LLC is exempt from the requirement to hold an Australian financial services licence in respect of financial services provided to wholesale clients in Australia. PIMCO LLC is regulated by the Securities and Exchange Commission under US laws, which differ from Australian laws. | PIMCO Japan Ltd, Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No. 382. member of Investment Management Association of Japan and Type II Financial Instruments Firms Association. All investments contain risk. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Taiwan Limited is an independently operated and managed company. The reference number of business license of the company approved by the competent authority is (115) Jin Guan Tou Gu Xin Zi No. 006. The registered address of the company is 40F., No.68, Sec. 5, Zhongxiao East Rd., Xinyi District, Taipei City 110, Taiwan (R.O.C.), and the telephone number is +886 2 8729-5500 | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | Note to Readers in Colombia: This document is provided through the representative office of Pacific Investment Management Company LLC located at Carrera 7 No. 71-52 TB Piso 9, Bogota D.C. (Promoción y oferta de los negocios y servicios del mercado de valores por parte de Pacific Investment Management Company LLC, representada en Colombia.). | Note to Readers in Brazil: PIMCO Latin America Administradora de Carteiras Ltda.Av. Brg. Faria Lima, 3477 Itaim Bibi, São Paulo - SP 04538-132 Brazil. | Note to Readers in Argentina: This document may be provided through the representative office of PIMCO Global Advisors LLC AVENIDA CORRIENTES, 299, Buenos Aires, Argentina. | No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America LLC in the United States and throughout the world. ©2026, PIMCO.

CMR2026-0728-5789792

A message from Advisor Perspectives and VettaFi: Discover something new! Click here to register for our upcoming webcasts.

Back to top

© PIMCO

Read more commentaries by PIMCO