Geopolitics put oil traders on edge

Reuters/Mohamed Abd El Ghany

Global oil traders are hooked on their news feeds, watching events unfold in the Middle East to see which way crude prices go next.

Not many see any downward movement from the $90 level in the weeks and months ahead.

The conflict in Gaza comes at a particularly sensitive time for oil markets. Months of cuts by the Saudi-Russia led Opec+ alliance, added to slow but appreciable recovery in big economies like China and the USA, have created a very tight market indeed.

Some experts predict a deficit of supply over demand in the second half of this year, continuing into 2024.

One indication of the paucity of oil on the market is the status of the US strategic petroleum reserve – down to its lowest level for 40 years, according to the Energy Information Administration recently.

In normal circumstances, Opec+ would be thinking of turning the taps back on at the end of the year when the current schedule of cuts expires. They have achieved their aim: Brent crude prices have recovered from the summer lows of near $70.

But these are far from normal circumstances. Although the conflict in Gaza does not pose any immediate threat to Gulf production or export, it all depends where it goes from here. Some commentators have talked about a doomsday scenario in which crude hits $200 a barrel, sparking a “global economic crisis”.

We are nowhere near that yet, it must be stressed, and it may never come to pass. Israel, Egypt and Lebanon – the three counties immediately in the firing line – are marginal players in global energy markets and eastern Mediterranean energy, mainly gas anyway, will not be missed from the crude equation.

Nonetheless, the conflict in Gaza is so unpredictable with so many possible scenarios unfolding, that it has the potential to have a severe impact on world energy markets.

As Capital Economics, the London consultancy, said: “The longer the conflict goes on, or the more widespread it becomes, the greater these risks will be.”

The International Energy Agency echoed that message. “A sudden escalation of geopolitical risk in the Middle East, a region accounting for more than one-third of the world’s seaborne oil trade, has put oil markets on edge,” they said.

Iran is at the heart of most of the calculations oil traders are currently making.

Analysts and policymakers are still assessing how much responsibility lies with Tehran for the initial attacks by Hamas. If it emerges that there was direct culpability, the least the Biden administration can be expected to do is to pull the shutters down on Iranian oil exports.

Washington has for some time been content to turn a blind eye, allowing Iran to produce and export crude, mainly to China and India, as long as it was in competition with Russian Urals, which of course the Americans are hoping to keep off global markets.

If the West was able to completely interdict Iran exports – a very big if – it would leave a big hole in global oil supply. Iran’s production is at a five-year high of over 3 million barrels a day (although it is difficult to say precisely how much of that goes for export). 

From there, the action could snowball quickly. If Hezbollah, the Iranian-sponsored group in the south of Lebanon, gets involved, that would make a wider conflict much more likely, even the possibility of direct Israeli-Iranian military confrontation.

In that case, Iran would surely be tempted to close the Straits of Hormuz entirely, especially if by that time its own exports were being blocked by the US.

The immediate impact on crude prices of such a move is almost impossible to calculate, but the prospect of an emotionally-led short-term spike to $200 a barrel level cannot be ruled out, though $150 is a fairer reflection of the market maths. 

Of course, we are nowhere near that situation at the moment. All the major oil analysts are sticking with their pre-Gaza estimates for the end-of-year price, which vary between a bearish $85 to $90 from Capital Economics and Citi, to a bullish $107 from Goldman Sachs.

But you get the feeling though that the next phase of global oil price movements will not be guided by cold-headed analysis, but by heat-of-the-moment trader reactions.

Many of these traders still remember the old market adage: “Buy on the sound of gunfire.”

Frank Kane is Editor-at-Large of AGBI and an award-winning business journalist. He also acts as a consultant to the Ministry of Energy of Saudi Arabia