Oil prices have fallen back to "pre-Iraq war levels"—is the market overreacting?

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Brent crude oil fell below $77/barrel this week, almost erasing all geopolitical premiums added since the outbreak of the Iran war, reaching the lowest level since the conflict began. However, several analysts warn that the futures market is pricing in a supply recovery that has not yet truly happened, showing a significant divergence between the optimism of financial markets and the reality in the physical oil market.

On Wednesday night, the US and Iran signed a 14-point memorandum of understanding. The US Central Command immediately confirmed that the blockade of the Strait of Hormuz had been lifted and reported oil tankers passing through the waterway. Brent crude oil dropped to $76.54/barrel intraday before recovering slightly to close at $79.85; WTI closed down 0.2% at $75.85, hitting its lowest level since the conflict began. The US national average retail gasoline price fell below $4 per gallon to $3.999, but still about $1 higher than before the war.

Since the May peak of over $100/barrel, Brent has accumulated a drop of more than 25%, and the market is quickly betting on a massive return of Middle Eastern crude oil to the global market. However, from the absence of shipping insurance, freight rates that are still three times pre-war levels, to the continued global inventory depletion at nearly 4 million barrels per day estimated by the International Energy Agency (IEA), the fundamentals are much more complicated than market pricing suggests.

This race between financial and physical markets is becoming the central point of divergence in current oil price trends. Multiple institutional analysts believe this downturn risks overshooting, but others note that expectations for lifting Iran sanctions are not fully priced in yet—if confirmed, oil prices could face further downward pressure.

Hormuz reopening, sentiment driving the decline

The direct trigger for this sharp drop in oil prices was the signing of the US-Iran memorandum of understanding. According to the framework, Tehran will reopen the Strait of Hormuz—which under normal circumstances carries about one-fifth of the world’s daily oil trade flows—in exchange, Washington will lift the blockade of Iranian ports and its oil export sanctions and start a 60-day window for nuclear agreement negotiations. Iran also pledged never to develop or acquire nuclear weapons.

The market's reaction was immediate: sell first, ask questions later. Trump proclaimed loudly on TruthSocial: "Oil is flowing...the stock market is roaring...you're welcome!"

Goldman Sachs analyst Yulia Zhestkova Grigsby estimated in a research report that Persian Gulf oil exports could return to pre-war levels by the end of July, but pointed out that full recovery still faces several obstacles. Kpler senior crude analyst Navin Das also stated that oil price drops following the agreement reflect limited reduction in geopolitical price premium, combined with expectations of Hormuz flow recovery, which together put pressure on spot prices.

Shipping market not convinced: freight rates remain triple pre-war levels

However, in stark contrast to the optimism in futures markets, the shipping market has yet to reflect this peace expectation.

Reports say Sinopec attempted to charter a VLCC to load Iraqi crude between June 25–30, received six quotes, all close to three times pre-war freight rates, and ultimately failed to close a deal. PetroChina’s reasoning made the issue clear: "There’s a tanker, but it's too expensive and you can’t be sure it can pass through the strait." Meanwhile, Indian Oil received zero bids for similar tenders; Sinochem is still searching for ships.

Argus Media Gulf & Middle East editor Nader Itayim pointed out, the market is too optimistic about the impact of the agreement and may overestimate the scale and speed of supply normalization. "Although there is oil ready to be exported in the GCC region, that incremental supply may not arrive immediately," he said. "Logistical bottlenecks need to be resolved before flow returns to normal levels."

Goldman Sachs analyst Yulia Zhestkova Grigsby also wrote in her report that many ship owners remain cautious regarding transit guidance, and shippers’ risk aversion is a potential limiting factor, along with Iran’s geopolitical aims during the 60-day window for nuclear talks, all contributing to uncertainty.

Inventory data issues warning: fundamentals do not support optimism

The fundamentals of the physical crude oil market draw a clear warning line to this sharp decline.

IEA estimates that since the outbreak of hostilities at the end of February, global inventories have been dropping at nearly 4 million barrels per day. US crude stocks have fallen over 50 million barrels in the past nine weeks, and Cushing storage levels hover near operational minimums according to most analysts. For countries that have been drawing down strategic and commercial reserves for months, restocking will ultimately be necessary.

Looking at the Brent futures curve, returning oil prices to pre-war lows (around $70/barrel) is expected only by March 2031—making a sharp contrast with the aggressive pricing in today’s futures market.

Bloomberg also notes that if Hormuz flow substantially resumes, the Asian market will face further pressure: Asian refineries previously replaced disrupted Middle Eastern crude with US and other alternatives, partially cutting processing volumes, and are now facing a sudden influx of Persian Gulf crude. This has already flipped the Middle East crude futures curve into a bearish contango structure, with markets pricing for near-term surplus rather than shortage.

Agreement framework itself leaves questions

Besides the pace of supply recovery, the text of the agreement itself contains several ambiguities, adding further uncertainty for the market.

The memorandum stipulates that commercial vessels "are exempt from transit fees only for 60 days," but Trump told media that the strait would remain "free to pass" after 60 days; this was not written into the agreement. Itayim also emphasized that this is not a comprehensive peace plan the market can fully rely on, but a temporary framework to reduce conflict and open a window for further negotiations. The market will therefore continue to keep some risk premium in prices.

Kpler analyst Navin Das highlighted another aspect: The far end of the price curve has begun to partially reflect the possibility of an easing in Iran sanctions, but that factor is not yet fully priced in—after the 60-day negotiation window, if formal confirmation is made, oil prices will face further downside risk.

Multiple analyses converge on a central contradiction: the financial market treats the agreement signing as a signal and rapidly prices in expectations for supply resumption; while the physical market—including shipping insurance, tanker scheduling, mine clearing, and production restart—follows a completely different timeline. Currently, the market is trading a preliminary framework as if it’s a completed supply restoration plan, while the physical market is still waiting to see it implemented.

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