From supply shock to oil glut: IEA flags scale of demand destruction caused by Iran war

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The oil supply shock caused by the Iran war has eroded global demand for crude — but a lasting resolution to the conflict could drive a surge in supply volumes and trigger a major oil overhang next year, the International Energy Agency said on Wednesday.

In its latest monthly oil market report, the IEA slashed its 2026 demand outlook to 1.1 million barrels a day year-over-year in 2026. That's a 700,000-barrel-per-day downgrade from last month's estimate, after deliveries plunged by 5 million barrels per day in the second quarter, the IEA said.

Global supply, meanwhile, slumped to 94.5 million barrels a day in May, down 600,000 barrels a day month-on-month. That dragged output to 13.6 mb/d, well below pre-war levels.

The IEA said global supply is now expected to drop by 3.9 mb/d year-on-year in 2026 to 102.4 mb/d, before rebounding strongly to 110.3 mb/d next year.

The drop in demand reflects the combined pressure of elevated fuel prices and shortages of refined products, the agency noted, underscoring how the conflict has moved beyond a straightforward supply shock.

'Significant overhang'

However, the IEA said supply is expected to surge by around 8 million barrels per day to roughly 110 mb/d, heavily outweighing a modest recovery in global oil demand of 2 million barrels per day to 105.3 million barrels per day in 2027.

"Our first look at 2027 balances shows a significant overhang emerging next year," the IEA said.

The report comes as investors weigh how the agreement between the U.S. and Iran to end the Middle East conflict, and a potential reopening of the Strait of Hormuz, will impact energy markets.

Oil prices have tumbled to a three-month low ahead of the U.S.-Iran deal signing in Geneva on Friday, as three Iranian tankers carrying nearly five million barrels of crude oil passed through the U.S. Navy blockade in the Strait of Hormuz.

Brent crude, the international price benchmark, was last seen 0.7% lower on Wednesday at $78.44. U.S. West Texas Intermediate futures for July delivery were almost 1.1% down at $75.18.

"If the deal holds, exports and production from the Gulf should see a gradual recovery — not least because Iranian oil exports can fully resume once the U.S. blockade is lifted," the IEA wrote.

Supply normalization could take months

The report's authors noted how shipments through the Strait rebounded sharply earlier this month, supported by ship-to-ship transfers in the Gulf of Oman, which have helped boost total flows from a May low of 9.6 mb/d to around 12 mb/d.

However, the IEA warned that a full recovery may not be immediate.  "Mines will have to be removed from the main shipping lanes and supply chains will take time to normalize," the IEA added.

The IEA also sounded a cautious note regarding pressure on global oil stocks.

Observed global inventories fell by 143 million barrels in May, accelerating the 74 million barrel draw in April. Inventories have now shed about 3.8 million barrels per day since the conflict began on Feb. 28.

"Despite the significant reductions in demand for crude oil and refined products, the buffers in the system continue to erode at a record pace," the IEA observed. "Further declines in the coming months could still take global oil stocks to historic lows before the market balance shifts to surplus towards the end of the year."

Tamas Varga, analyst at PVM Oil Associates, said that despite deep inventory drawdowns, oil prices are now "within spitting distance" of their late February levels.

"The current baseline is that the Strait of Hormuz will reopen and that ships will begin transiting through this critical chokepoint in both directions. The gradual resumption of oil flows, however slow, will materially affect the oil balance. The salient question is by how much," Varga said.