ISLAMABAD: When the US and Iran signed the Islamabad Memorandum of Understanding (MoU), financial markets initially celebrated what appeared to be the end of the most dangerous Middle Eastern conflict in decades.
Yet one thing has puzzled investors, governments and consumers alike. If the war is over, why have oil prices not collapsed back to the $65-70 per barrel range that prevailed before hostilities erupted?
The answer lies in a simple but often overlooked fact. While the Islamabad MoU has significantly reduced geopolitical risk, it has not restored the vast physical energy system that was damaged during months of conflict. As a result, oil markets continue to price in shortages, logistical disruptions, inventory depletion and uncertainty that extend far beyond the battlefield.
The first reason is that crude oil production and crude oil delivery are two different things. Before the conflict, roughly 20 per cent of globally traded oil moved through the Strait of Hormuz. During the war, attacks on shipping, naval confrontations and security concerns disrupted tanker traffic throughout the Gulf. Although the waterway has reopened, shipping networks remain far from normal. Many shipowners continue to exercise caution, meaning the restoration of normal oil flows is occurring gradually rather than immediately.
The second and perhaps most important reason involves refining capacity. During the conflict, damage was inflicted not only on oil fields and export terminals but also on refineries throughout the Gulf.
Industry estimates suggest that approximately 1.9 million barrels per day of refining capacity was initially knocked offline, while subsequent assessments placed total affected refining capacity as high as 3.52 million barrels per day.
Unlike oil wells, refineries are extraordinarily complex facilities. A damaged distillation unit, catalytic cracker, hydrogen plant or control system can take weeks or months to repair. Even after repairs are completed, operators must conduct inspections, safety certifications and test runs before returning units to full utilisation.
Among the most significant facilities affected was Saudi Aramco Total Refining and Petrochemical Company (SATORP) in Jubail. CEO of TotalEnergies says SATORP will not be fully operational until early 2027. Total Energies has 32.5 per cent shares in SRORP. Right now it is running 70 per cent of its capacity.
With a capacity of approximately 460,000 to 465,000 barrels per day, SATORP is one of the largest and most sophisticated refineries in the world. Reports indicated that one of its two processing trains suffered damage, reducing throughput substantially. At various stages following the attacks, the refinery was believed to be operating at roughly half its nameplate capacity, implying that nearly 230,000 barrels per day of refined products were temporarily removed from global markets.
SATORP was not alone. Saudi Arabia’s Ras Tanura refinery, with capacity of roughly 550,000 barrels per day, suffered disruptions before gradually restarting operations. Yanbu refinery also experienced interruptions. In Kuwait, the giant Al-Zour refinery, capable of processing approximately 615,000 barrels per day, reduced throughput during the conflict. Kuwait’s Mina Al-Ahmadi refinery, with capacity of around 346,000 barrels per day, and Mina Abdullah refinery, capable of processing approximately 270,000 to 280,000 barrels per day, also operated below normal levels. Bahrain’s Sitra refinery sustained damage and faced prolonged recovery challenges. Collectively, these facilities account for well over 2.5 million barrels per day of refining capacity, explaining why refined fuel markets remain tight despite the ceasefire.
The third reason concerns inventories. During the conflict, governments, refiners and traders drew heavily upon strategic reserves and commercial stockpiles. Energy analysts estimate that hundreds of millions of barrels of crude oil and refined products were withdrawn from storage to offset disruptions. Some industry assessments suggest the cumulative drawdown approached one billion barrels across crude and product inventories. Markets now face a dual challenge: meeting current demand while simultaneously rebuilding depleted reserves. This restocking process creates additional demand that supports prices even after supply disruptions begin to ease.
Another factor often overlooked is the distinction between crude oil and refined products. Consumers do not burn crude oil directly. They consume gasoline, diesel, aviation fuel, heating oil and petrochemical products. Even if crude production recovers quickly, shortages of refined products can persist for months. Diesel markets in Asia remain significantly tighter than before the conflict. Jet fuel markets continue to face constraints due to reduced Gulf exports. Strong refining margins encourage refiners to compete aggressively for crude supplies, preventing crude prices from falling as rapidly as many expected.
Opec and Opec+ production policy constitutes another major reason prices have not returned to pre-war levels. Before the conflict, the alliance was already managing production through a series of coordinated output targets designed to support market stability. Now, the group has shown little interest in flooding the market with additional barrels immediately after the conflict.
Iran itself presents another layer of complexity. Although the MoU has reduced tensions, questions surrounding sanctions, nuclear negotiations and future diplomatic arrangements remain unresolved. Markets continue to debate how quickly Iranian exports can increase and whether any sanctions relief will be sustained. Because these issues remain uncertain, traders are unwilling to assume a rapid influx of Iranian crude into global markets.
The labour and engineering constraints created by the conflict also continue to affect recovery efforts. Specialised refinery equipment, replacement parts, industrial control systems and engineering crew are in high demand throughout the region. These bottlenecks inevitably slow the pace of recovery.
Insurance costs remain another hidden source of support for oil prices. War-risk premiums for vessels operating in the Gulf surged dramatically during hostilities. Although rates have declined since the signing of the MoU, they remain elevated compared with pre-war conditions.
Markets are also pricing a geopolitical risk premium. Investors remember that many ceasefires and political agreements in the Middle East have failed in the past. The Islamabad MoU may have halted active hostilities, but it has not yet established a long-term security architecture for the region. Traders continue to assign a probability, however small, to renewed tensions, disruptions or military incidents. As long as such risks remain, a portion of the wartime premium will remain embedded in oil prices.
