Geopolitical Risks Significantly Cooled, Leading to a 7% Drop in Oil Prices

May 7th News

On Wednesday, May 6, the international crude oil market experienced a sharp sell-off, with both WTI and Brent crude oil futures plunging sharply to two-week lows. The primary reason was the rapid erosion of the geopolitical risk premium in the Middle East, driven by optimistic expectations of breakthrough progress in U.S.-Iran peace negotiations. Despite the release that day showing continued declines in U.S. crude oil and refined product inventories—positive news for supply—the decline in oil prices could not be reversed.

I. Price Trends: Both Oil Contracts Plunge, Falling Across the Board to Two-Week Lows

On May 6, international crude oil futures plunged. The June main contract for U.S. WTI crude oil closed at $95.08 per barrel, down $7.19, or 7.0%. The most actively traded July contract for Brent crude oil closed at $101.27 per barrel, down $8.60, or 7.8%. Both crude oils hit two-week lows.

Finished oil prices plunged in tandem: June RBOB gasoline futures fell by 16.13 cents, closing at $3.4593 per gallon; June heating oil futures dropped by 24.46 cents, settling at $3.7856 per gallon. Both price declines exceeded 4%, following the downward trend of crude oil prices.

II. Trend Analysis: Prospects for U.S.-Iran Talks Look Promising; Expectations for Navigation Through the Strait of Hormuz Heat Up.

The core factor behind this sharp drop in oil prices is the market expectation that the U.S. and Iran are about to reach a preliminary peace agreement. High-level officials from both sides have been issuing frequent positive signals, leading the market to conclude that the Middle East conflict will likely ease, shipping through the Strait of Hormuz is expected to resume, and the supply gap will gradually narrow.

1. The U.S. and Iran Send Positive Signals; Peace Talks Achieve Substantial Progress

The U.S. side expressed optimism and revealed the framework of the agreement: In an interview on the 6th, U.S. President Trump explicitly stated that he is optimistic about the prospects of reaching an agreement between the U.S. and Iran, adding that the agreement might include a provision under which Iran would ship highly enriched uranium to the United States. According to the White House, the two sides are close to finalizing a one-page memorandum of understanding containing 14 key provisions, with the core objective being to bring hostilities to an end and establish a framework for subsequent nuclear negotiations. Later that day, at the White House, Trump further disclosed that the past 24 hours of U.S.-Iran dialogue had been “very productive,” and the likelihood of reaching an agreement was extremely high.

The Iranian side has responded cautiously and is currently in the assessment phase: The Iranian side stated that it has not yet provided its feedback to Pakistan, the mediating party, on the U.S. 14-point proposal. It is now in the assessment stage and has not explicitly opposed the peace talks’ progress, leaving room for future negotiations.

2. Core Market Logic: The expectation of cross-strait shipping alleviates supply concerns.

The Strait of Hormuz is a critical chokepoint for global oil transportation, handling about 30% of the world’s crude oil shipments. Since the conflict erupted in February, disruptions to shipping through the strait have directly created a supply gap of roughly 13 million barrels per day, causing global oil and fuel inventories to continue declining—a key factor underpinning persistently high oil prices.

Following the optimistic news about U.S.-Iran peace talks, the market generally expects that shipping traffic through the Strait of Hormuz will gradually resume. Market participants widely believe that, regardless of whether a lasting peace agreement can be reached, the likelihood of the strait reopening has significantly increased. The very possibility of reaching an agreement has already triggered a drop in oil prices, and once the agreement is formally announced, it will further drive oil prices down from their premium levels and return them to normal.

At the same time, it’s important to note that there is a certain lag in the recovery of shipping operations. Even if the strait resumes normal navigation, it will take 6 to 8 weeks for global oil flows to return to normal. As a result, supply shortages will persist in the short term; however, in the long run, the risk to crude oil supply will decline significantly across the board.

3. Inventory Data: Although the fundamentals of tight supply and demand remain, market sentiment is taking the upper hand.

On the same day, inventory data released by the U.S. Energy Information Administration (EIA) for the week ending May 1 showed that U.S. crude oil and refined product inventories continued to decline, reflecting that the underlying global supply-demand balance remains tight. However, driven by geopolitical sentiment, the supportive effect of these inventory declines on oil prices has almost disappeared.

EIA data show that U.S. crude oil inventories fell by 2.3 million barrels to 457.2 million barrels. Although this decline was smaller than the analysts' expectation of a 3.3-million-barrel drop, it marked several consecutive weeks of inventory reductions. The underlying reason is that countries around the world are racing to fill the supply gap created by the conflict in the Middle East, keeping crude oil demand robust. Inventories of refined petroleum products also saw significant declines, with distillate fuel oil stocks hitting a 20-year low. Gasoline inventories fell by 2.5 million barrels to 219.8 million barrels, exceeding analysts' expectations of a 2.1-million-barrel decline, largely driven by a surge in petroleum product exports to record highs. Distillate fuel oil inventories (including diesel and heating oil) declined by 1.3 million barrels to 102.3 million barrels, reaching their lowest level since 2005, highlighting the tight global refined oil supply situation and further confirming the fundamentally tight supply-demand balance.

III. Outlook for the Future Market: Short-term volatility is set to intensify; in the medium to long term, it will depend on the implementation of the agreement and the resumption of supply.

According to crude oil analysts, the current crude oil market is in a phase of short-term focus on geopolitics and medium-to-long-term focus on supply and demand. The subsequent trend of oil prices will concentrate on the following key variables:

Progress on the U.S.-Iran agreement: Currently, peace talks remain in the expectation phase, and Iran has yet to formally respond to the U.S. proposal. Should subsequent negotiations hit obstacles or collapse, geopolitical risk premiums will quickly re-emerge, potentially triggering a rebound in oil prices. On the other hand, if the agreement is formally signed and implemented, and navigation through the Strait of Hormuz resumes, oil prices will further revert to pricing driven by supply-and-demand fundamentals. Given that it will take some time for supply to fully recover, and considering that global inventories are currently at exceptionally low levels, there may be limited room for oil prices to decline sharply; instead, prices are more likely to fluctuate within a medium-to-high range.

Moreover, from a supply-and-demand fundamentals perspective, with expectations of a global demand recovery and the North American summer travel peak approaching, global crude oil demand is poised to continue growing. Coupled with the potential support from OPEC’s continued production cuts, the likelihood of a significant long-term decline in oil prices is relatively low.

In summary, yesterday’s sharp drop in oil prices is a direct reflection of the easing of geopolitical risks in the Middle East. In the short term, sentiment-driven shocks are dominating the market, but the underlying fundamentals—tight supply and demand—have not fundamentally reversed. Going forward, the market will need to closely monitor three key factors: progress in U.S.-Iran negotiations, the resumption of shipping through the Strait of Hormuz, and global inventory changes. These three variables will collectively determine the medium-term trend of oil prices.