IEA warns: War in Iran drags down oil demand by the largest drop since the pandemic, warning of further weakness in the coming months.

Brent crude oil prices fell sharply after hitting the $110 mark, and the International Energy Agency (IEA) issued a warning at the same time: the ongoing war with Iran continues to drag down global oil demand, with the decline in demand this year already the largest since the COVID-19 pandemic, and it may shrink further in the coming months.

According to Bloomberg, the IEA revised its forecast for the decline in global oil demand this year to 2.5 million barrels per day in its September monthly report, a deepening of 940,000 barrels per day from the previous month's forecast, representing the largest annual drop in demand since the impact of the COVID-19 pandemic in 2020.

The IEA no longer expects the Strait of Hormuz to reopen to shipping this year , and warns that with supply remaining constrained and commercial inventory buffers rapidly depleted, "the coming months may require further compression of demand to close the supply-demand gap," and that 2026 and 2027 will be a "lost period" for global oil demand growth.

Affected by the aforementioned warning, Brent crude oil futures fell sharply by about 3.5% from an intraday high approaching $110, dropping to around $103. Despite this, oil prices still recorded their biggest weekly gain since July, with a year-to-date increase of over 70%.

The supply gap continues to widen, and inventories are declining at a record pace.

The IEA, in its report, lowered its forecast for the average annual decline in global oil supply this year to 5.7 million barrels per day, a further reduction of 1.3 million barrels per day from its previous forecast, and postponed its expectation of supply recovery to next year . Taking both supply and demand into account, the global oil supply deficit this year is projected to be approximately 1.75 million barrels per day, higher than the 1.3 million barrels per day forecast in last month's report.

The IEA characterized the crisis as a "record supply disruption".

The report shows that global oil inventories declined at a faster rate of 2.8 million barrels per day between February and August this year. Inventories are expected to continue declining in the fourth quarter, whereas the IEA had previously predicted a slight increase during the same period. The IEA's August report also predicted that the market would return to a supply glut by the end of the year, a prediction that has now been completely overturned.

The Hormuz crisis impacted distribution; the war's effects on supply exceeded those on demand.

The IEA points out that the war has had a greater impact on oil distribution than on consumption, which is the core reason for the continued widening of the supply gap. The chokepoint of the Strait of Hormuz remains blocked, and attacks on energy infrastructure have extended from the Persian Gulf to the Russia-Ukraine conflict.

According to Bloomberg, the Iranian-backed Houthi rebels claimed to have struck Saudi Arabia's East-West oil pipeline—a key alternative route bypassing the Strait of Hormuz, connecting to the Red Sea's export terminal. Simultaneously, the Houthis are advancing along the coast adjacent to the strategic Bab el-Mandeb Strait, approaching the port of Mokah at the southern end of the Red Sea. Saudi oil production declined again last month, falling to its lowest level since 1990.

" The renewed full-scale war between Saudi Arabia and the Houthis could be a catalyst for our scenario of high oil prices," wrote Helima Croft, an analyst at RBC Capital Markets, in a research report.

Diesel shortages are impacting the global market, with Asia's petrochemical industry bearing the brunt.

The IEA warns that the impact on oil demand in 2026 will be comparable to the four largest energy crises in the past 60 years, with the most concentrated impact on middle distillates such as diesel and feedstock supplies to Asian petrochemical plants.

The diesel shortage has triggered a chain reaction globally. The U.S. diesel crack spread is currently around $110 per barrel, and the average retail price of industrial diesel across the U.S. has reached a record high of $6 per gallon, with some gas stations in California exceeding $9.99 per gallon.

Hamad Hussain, a commodities analyst at Capital Economics, warned that depleted inventories coupled with early signs of a recovery in Chinese demand make oil prices highly sensitive to any new disruptions to Middle Eastern supply. Jeff Currie, former head of commodities at Goldman Sachs and now head of Real Macro, told CNBC that Chinese buyers are actively entering the market to bid for crude oil, adding, "I actually value China's return to the market more."

Diplomatic efforts are showing signs of improvement; the market is closely watching the developments in the Gulf situation.

Amid escalating geopolitical tensions, a slight sign of easing has emerged on the diplomatic front. According to Bloomberg, the six Gulf Cooperation Council (GCC) members are considering holding talks with Iranian officials next week to discuss the issue of passage through the Strait of Hormuz.

UBS analyst Justinus Steinhorst noted in a research report: "Brent crude oil remained above $105 amid concerns about a double chokepoint between the Houthi rebels and the situation in the Bab el-Mandeb Strait. The yield on 10-year German government bonds rose to its highest level since 2009, and the yield on 10-year US Treasury bonds also approached the 5% mark."

The core contradiction facing the market today is that the damage to the supply side caused by the war far exceeds the natural adjustment speed of the demand side. The latest warning from the IEA suggests that, with the prospects for supply recovery still unclear, passive compression of the demand side may become the only way to balance the market.

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