Why Oil Shortages May Bring Lower Prices–and Recession

There have recently been many warnings about near-term oil shortages stemming from the conflict in Iran. Most analysts assume that shortages mean higher prices. As I will explain, the dynamics of a self-organizing economy suggest the opposite outcome — lower prices, deepening recession, and shortages of goods and services that have little to do with price.

Figure 1. Wile E. Coyote and Road Runner cartoon showing Wile very surprised after he runs past the edge of the cliff. Source.

Rather than high prices, my major concerns are recession and the disappearing availability of goods and services that we rely on. This might be similar to the empty shelves that many stores experienced in 2020 and 2021. There may also be new government restrictions, intended to work around the reduced oil supply in a way that will allow essential services to continue to operate normally. Oil prices are likely to fall below $40 per barrel, as they did in 2020 with Covid restrictions.

In this post, I will try to explain why this counterintuitive outcome — shortages leading to lower prices rather than higher — is what the self-organizing economy tends to produce. Along the way, I will look at the current state of oil reserves, why the conflict with Iran is unlikely to be quickly resolved, and what the price behavior of oil since February 28 tells us. I will also step back to consider the broader picture: why war can seem like a solution to struggling economies, and what the 2020 Covid experience might teach us about what lies ahead.

[1] Reserves of already-pumped US oil have dropped to concerningly low levels.

On June 17, President Trump said, “We will run out of reserves in about four weeks without a deal.” According to the article, we are not certain whether Trump intended to apply this statement to US or world emergency reserves.

Also, according to this recent video, the US’s largest tank farm seems to be very close to the minimum level at which crude oil can be withdrawn from its tanks. And, on June 23, MSN said, “America may see actual gasoline shortages by July 4.”

The already-pumped oil in storage is intended to be used as a buffer if there are variations in supply or demand. The reason that these buffers are falling low is because considerable oil from them has already been used to mitigate the shortfall in crude oil supply to date.

The shortfall in the supply of crude oil supply cannot be expected to disappear quickly. There has been considerable damage to infrastructure in Iran and elsewhere. It will take years rather than months for this to be repaired. In countries where oil production has been shut in, some wells are likely to produce less after being reopened following many months of closure. Furthermore, Iran has no incentive to completely reopen the shipping lanes, since keeping them potentially closed has the potential to raise oil prices per barrel. Higher oil prices would help the finances of Iran.

[2] Perhaps because of concern about low buffer supplies, the US has negotiated a deal with Iran that seems unfavorable to the US.

Information keeps coming out that indicates that Trump’s current Memorandum of Understanding (MOU) is very favorable to Iran. It looks as if the MOU has been written as if Iran won the war. We are also seeing that other countries have begun acting as if Iran has indeed won the war. For example, on June 23, a joint statement was issued by Iran and Oman. The two countries seem to be co-operating in setting up the collection of funds from ships passing through the strait to cover insurance and other costs.

If we are dealing with a “done-deal,” and the US is coming out poorly, the level of conflict within the US is likely to rise. Many people will be angry with Trump for getting the US into the war to begin with. Unfortunately, there is likely close to nothing we can do about this situation.

[3] Trump or another leader cannot restart the war against Iran and expect to do any better.

A major problem is that the US has substantially depleted its ammunition supplies, and it will take years to replenish them. While the US could perhaps launch a short attack, it would not be able to carry out a sustained campaign for very long.

Another issue is that the armaments that the US has stocked to date are designed to be used in a different type of war than the one that is being fought today. The US needs drones and close-by locations from which to launch them. Iran damaged most of the US’s bases that are close to Iran in the conflict that began on February 28. Without substantial rebuilding, the US has no functioning bases close to Iran from which to launch such drones.

Restocking armaments will likely take several years, especially if new types are needed. Adding to the difficulties of the US is the fact that China has been the primary source of many critical minerals used in the production of high-tech goods and ammunition. In recent years, China has restricted access to these critical elements. The US is now developing mines for some of these minerals, but setting up entire supply chains will take years.

[4] One motivation for attacking Iran might have been to raise oil prices to a higher level.

Based on their models, economists typically reach the conclusion that inadequate oil supplies will lead to high oil prices. It is likely that President Trump and his advisors believed that inadequate oil supply would lead to high oil prices.

Some analysts, including me, would argue that the models of economists are very inadequate; they give misleading indications by leaving out the complex self-organizing nature of the economy.

Higher oil prices are sometimes desirable because they encourage more oil extraction. For example, higher prices allow marginal wells to continue to be profitable longer. They can also make a new, higher-cost source, such as tight oil from shale, attractive for drilling. Looking ahead, higher oil prices would make it easier to get oil company support for ramping up oil production in Venezuela.

Figures 2 and 3 show the connection that higher oil prices seem to have had in encouraging tight oil extraction from shale. Figure 2 shows historical oil prices, adjusted for inflation. Noted on this figure is my view of whether prices were high enough to encourage extraction from more difficult locations.

Figure 2. Figure showing historical average annual inflation-adjusted oil prices, based on data of the 2025 Statistical Review of World Energy, published by the Energy Institute. The 2025 average oil price is estimated based on EIA data. Comments on price levels have been added, as well. An underlying issue is that the price of oil extraction has tended to rise faster than inflation.

Figure 2 indicates that prices started to run up in the 2003 to 2008 era, when China started ramping up its manufacturing, and thus its demand for oil. In this same timeframe, there was also a growing demand for housing in the US, thanks to very liberal underwriting standards for home mortgage loans. Thus, the total demand growth for oil was very high.

Figure 3 shows that production of tight oil started ramping up in 2009, after oil prices had been rising for several years.

Figure 3. Monthly tight oil production, in figure produced by the EIA.

Another factor in the growth of tight oil production was the availability of cheap credit after 2008, but this has tended to disappear since 2021. Now, tight oil production seems to be leveling out, leading to rising concerns that tight oil production may soon decline, especially if credit is no longer cheap. Having higher oil prices might help postpone the decline of tight oil.

[5] Oil prices since the war started on February 28 have not bounced very high. Recently, they have tended to fall back, close to their pre-war level.

Figure 4. West Texas Intermediate benchmark oil prices, mostly based on EIA data. Most recent points based on Wall Street Journal charts. Amounts through June 26, 2026.

The first thing to note is the fact that the prices on Figure 4 do not reflect the actual prices to the consumer, which have often been greater. The cost of transporting oil has jumped in many markets, but this higher transport cost is not reflected in the “West Texas Intermediate” price of oil, displayed in this chart. These higher prices at the pump have led some of the more price-sensitive buyers of oil products to cut back on their purchases.

Second, there is a lag issue regarding how soon the impact of missing supply actually hits the market. The slow transit time of oil from the Middle East to markets means that the actual disruption of supplies did not hit until at least 50 days later. If crude oil first needs to be processed by local refineries and then the oil products shipped to customers, the lag would be even greater–perhaps 75 or 100 days in total. Thus, much of the price increase to date may be based on a fear of shortages, rather than on an actual shortage issue.

Third, there have been some changes that impact oil “demand.” Some consumers have been told by their governments to work from home or otherwise restrict their driving to save on oil consumption. Also, some flight schedules have been cut back. Recently, Ukraine has been targeting some of the oil infrastructure of Russia, leading to reduced gasoline and diesel availability within that country. All these issues have tended to reduce the demand for oil. The lower demand acts to hold down oil prices.

A fourth issue has to do with worldwide economic conditions before February 28. Even before the war, much of the world was in close to a recessionary situation. There were very many low wage earners who could not afford much beyond the basic necessities of life. Even a small run-up in oil prices tends to affect food prices because oil is often used in farming operations and food is usually transported to market using oil. With higher food prices, poor consumers were forced to cut back on other purchases. This recessionary dynamic can be expected to get worse if oil prices inch up even a bit.

[6] I expect that oil prices will continue to remain relatively low, or they will only briefly rise to high ($150+) levels, even if there are actual oil supply disruptions.

I expect that the dynamics we have been seeing since February 28 will continue, and may intensify. Governments will add new restrictions that will reduce oil use. Airlines will go bankrupt, or they will reduce flight schedules. Recession will become even more of a problem. These issues will tend to reduce usage without raising prices.

[7] What we may see more of is broken supply chains.

There will be more signs in grocery stores and in home product stores saying, “This product is temporarily unavailable.” Car repair shops may tell us that a required replacement part will not be available for several months. Physicians may tell us that a medicine or chemotherapy drug that they normally use is, at this time, unavailable.

[8] The operation of the economy depends on an adequate supply of many kinds of energy. If oil supply is reduced, an economy needs to shrink to a smaller size to match. This is what leads to recession.

One reason for the above observation is that we know that our own vehicles will not operate without whatever fuel they are designed for. This is clearly also true for all the delivery trucks in the world, and for farm machinery and for ships that transport goods across the ocean. With less fuel, fewer trips of many kinds will be made. Workers will be laid off. This dynamic sounds a lot like recession.

The expected lower world oil supply in the near future is not an issue that can easily be resolved. We are already seeing that even with a supposed settlement, disruption in oil supplies seems likely to continue and even to worsen, as the various limits on buffer supplies are reached. Unfortunately, we cannot expect the situation to be completely fixed for several years.

Furthermore, the economy is facing even more disruptions than I have outlined above. For instance, Ukraine has been disrupting Russia’s oil infrastructure with drone attacks. There have also been disruptions to sulfur exports from the Middle East. Sulfur is used in many ways, including as a fertilizer and in the production of sulfuric acid, which is used in the mining of uranium, among other things. In addition, there have been disruptions to liquefied natural gas (LNG) exports from Qatar. The lack of these important products will tend to further damage supply chains and lead the economy deeper into recession.

[9] We are ultimately dealing with multiple not-enough-to-go-around scenarios. This situation will tend to increase conflict in the world.

The dynamic we are dealing with is similar to that in the game of Musical Chairs.

Figure 5. Chairs arranged for Musical Chairs Source: Fund Raising Auctioneer

The game of musical chairs is played in rounds. Players walk around the edge of a circle of chairs while music is played. When the music starts, the number of players is equal to the number of chairs. In each round, one chair is removed. The music plays and then suddenly stops. The players must then scramble to grab a chair. Since the number of chairs is now one fewer than the number of players, small fights can ensue.

The problem is basically, “Not enough to go around.” War often sounds like a reasonable solution to leaders.

[10] War can seem like a solution.

Strangely enough, war has multiple advantages to economies that are suffering from difficulties related to low commodity prices and, indirectly, low wages in related industries. One commodity is food. If food prices are too low, farmers will be unhappy that their earnings are low. They may stop farming and try to make a living from putting their land into a land bank and working elsewhere.

If oil prices are low, the oil industry can experience pockets of low wages. There have recently been reports of lockouts and strikes in the oil industry. I would expect these labor actions to be most prevalent where oil fields are depleted.

If a government announces a war, it looks like the government is “doing something” about the country’s problems. There is suddenly employment, either as a soldier, or in building armaments. GDP tends to rise because the war leads to a larger share of the population working. The war can be used to justify the additional government debt needed to hire the additional workers. What convinced me of this relationship was this chart, showing a huge increase in US GDP during World War II:

Figure 6. Three-year average increases in US inflation-adjusted GDP, based on data from the US Bureau of Economic Analysis. The last point is 2025.

Looking closely at the chart, it is also possible to see GDP increases during the Korean War (1950-1953) and between the time the US entered the Vietnam War, deploying up to 549,000 soldiers, and the time the US greatly reduced its forces there (1964-1969).

I think much of Europe is now in a situation in which war looks like a solution. Russia may also be in such a situation. Ukraine, with its problems, is also in such a situation.

[11] There may be lessons to be learned from the 2020 Covid restrictions and the ultra-low oil prices that resulted then.

Back in 2019, many people in the financial world were concerned about the economy. In 2019, the US faced significant financial issues, including a budget deficit that increased by $205.4 billion to $984.4 billion. In addition, in September 2019, there was a spike in the interest rates financial institutions charge each other (repo rates) that concerned those who followed financial markets closely.

What took place in 2020 seemed to some of us to be close to miraculous. The strange actions related to Covid greatly brought down the price of oil. Covid also provided an excuse to give money to households. US government debt was able to increase greatly, and, somehow, the world economic system has held together until now. Financial problems were “kicked down the road” a while longer. Without the pressure of financial problems, the economy could work on ways to mitigate the energy problem a while longer.

Economies are self-organizing systems, just as the human body is a self-organizing system. Both are powered by “energy dissipation.” Human bodies tend to heal wounds, like magic. Economists talk about an “invisible hand” being helpful to economies. In situations where the healing of economies does occur, low oil prices can be part of the magic.

[12] What might be ahead?

We are again in a period when the US and world economies are on shaky ground. Debt levels are high, and conflict levels are high.

As I have discussed in this post, I expect the general trend in oil prices will be down, rather than up. The major reason why oil prices are likely to be low is because, with the damage done in the Middle East, the quantity of oil supply available to the world is starting to shrink. As a result of the low oil quantity, the world will produce fewer goods and services. This is close to the definition of recession! (Also, on Figure 1, this is why we expect Wile E. Coyote to fall down, rather than to float up, when his support disappears.)

I expect as oil product shortages hit, local leaders will figure out ways to mitigate the oil bottleneck that the world now seems to be facing. Local leaders will enact rules that make certain that whatever oil is available is used to maintain essential services. It will not be surprising if local leaders keep people at home, using one excuse or another, to keep oil demand in line with the quantity of oil that is available. This is a big part of why oil prices will tend to be low, in a manner similar to 2020.

With low oil prices, I expect that inflation will be low. Pressure to keep raising interest rates will disappear. The economy will not be doing well, but the issue will not be high interest rates preventing new investment.

In my opinion, the world economy needs to reorganize with shorter supply lines to get through the oil “tight spot” that the economy is in. If supply lines could mostly be kept within the areas marked on Figure 7, it seems like a significant amount of transport fuel could be saved.

Figure 7. Map showing world divided into two areas of influence. In my opinion, supply lines need to increasingly come from within the same hemisphere. Areas marked in yellow represent my idea of future centers of trade..

The conflict with Iran doesn’t seem to be ending well for the US, but there might be a silver lining. The pain the US is experiencing in Iran will hopefully teach the US to stay out of issues in the Eastern Hemisphere. If a conflict with Iran is to ramp up again in the near future, I expect that it will be a European group that will be getting involved, not the US.

We don’t know quite what is ahead, but the experience in 2020 shows that a strange confluence of events leading to low oil prices can actually be helpful. Let us hope that a similar result will be possible this time.