The emergence of a new conflict in the Middle East is introducing fresh complexities to the global energy markets. This conflict between Palestine and Israel is burdening a struggling world economy at a politically sensitive juncture for leaders around the world.

The unexpected attack in Israel over the weekend, initiated by the Palestinian group Hamas, has prompted renewed demands from lawmakers for stricter U.S. sanctions against Iran. Additionally, it has cast a shadow over ongoing efforts to establish normalized relations between Israel and Saudi Arabia. The potential consequences of either of these outcomes loom large, with the prospect of exacerbating already elevated oil prices.

The oil trading community thus is keenly watching as the market prepares to reopen after the sudden outbreak of war in Israel. It is clear that the potential for this conflict to spread throughout the entire region is a significant concern.

Crude traders, for the time being, do not foresee a drastic surge in prices, given the absence of an immediate threat to the oil supply. However, all eyes are riveted on Iran, a significant oil producer and a crucial supporter of the Hamas group responsible for the recent offensive against Israel.

Should a retaliatory strike be launched against the Islamic Republic, it could fan the flames of anxiety concerning the vital shipping artery, the Strait of Hormuz, which Iran has previously threatened to close.

Oil-disruption scenario: supply, demand, and politics

Bob McNally, President of the Rapidan Energy Group and a former White House official, emphasizes that the “oil-disruption scenario” would become a stark reality if the conflict were to spread to Iran. For the present, such an outcome seems improbable, McNally reassures.

Yet, the perilous situation has arisen at a time when global crude supplies have already been dwindling due to months of stringent production cutbacks by Saudi Arabia and Russia. Just last month, these cuts briefly propelled Brent futures to the brink of $100 a barrel.

Hedge fund trader Pierre Andurand, the founder of Andurand Capital Management LLP, weighs in on the situation, stating, “It is unlikely to impact oil supply in the short term, but it could eventually have an impact on supply and prices.”

Remarkably, this onslaught transpires nearly half a century after the Arab oil embargo, a dark chapter in history when Saudi Arabia and other OPEC producers, in the aftermath of the 1973 Yom Kippur War, choked off oil flows to the Western world.

There is no expectation that Riyadh, which has been engaged in negotiations with Washington aimed at normalizing relations with Israel, will opt to cut off oil supplies in solidarity with the Palestinians at this juncture. At worst, the conflict may disrupt the ongoing normalization talks and thwart any potential increase in Saudi oil production.

Suhail Al Mazrouei, the Energy Minister of the United Arab Emirates and a pivotal member of OPEC, left no room for doubt on Sunday, asserting that the conflict would not influence the group’s decision-making. “We do not engage in politics; we govern by supply and demand, and we do not consider what each country has done,” he firmly stated during a press conference in Riyadh.

Iran’s support for Palestinian attack raises tensions in oil markets

Iran, an OPEC member, has openly expressed its support for the Palestinian attack.

If Israel were to respond by targeting any Iranian infrastructure, the consequences would be swift and dramatic, according to McNally. “Crude prices would immediately spike on the perceived risk of a disruption.”

The significance of Iranian oil in the global market has grown considerably, marked by a resurgence in shipments to a five-year high. This uptick has occurred with Washington’s implicit approval, as both sides engage in tentative diplomacy aimed at reinstating limits on Tehran’s nuclear program.

The recent hostilities over the weekend could push President Joe Biden’s administration to take a more assertive stance regarding these oil shipments, primarily destined for China. Andurand reflects on this possibility, stating, “I think this development will mean stronger enforcement of Iranian sanctions, resulting in less Iranian oil going forward. And then, who knows what the domino effect will be in the region?”

In a more dire scenario, Iran might respond to any direct provocation by blocking the Strait of Hormuz, a crucial maritime passage located just north of the Arabian Sea. On any given day, tankers transport nearly 17 million barrels of crude and condensate through this narrow waterway, which measures a mere 21 miles wide at its narrowest point. Tehran had previously threatened to close the strait when sanctions were imposed on the country in 2011, though it ultimately backed down.

The influx of Iranian oil barrels has played a pivotal role in stabilizing fuel prices throughout the year, even as Saudi Arabia and Russia, under the leadership of Vladimir Putin, employ tactics to tighten global supplies. Their coordinated efforts have led to a rapid depletion of oil inventories, resulting in a substantial price premium for immediate supplies, a phenomenon known in the industry as backwardation.

A warning amidst a bullish run

Gary Ross, a seasoned oil consultant turned hedge fund manager at Black Gold Investors LLC, emphasizes the intense tightness of the crude market. He observes that “physical markets are screaming, with backwardation heading higher, dragging the flat price higher.”

Brent Crude Oil Price:

Brent crude experienced an 11% drop and settled just below $85

Oil Production Data:

• Saudi Arabia reduced its oil output to approximately 9 million barrels/day but holds about 3 million barrels per day
• United Arab Emirates possesses an additional 1 million barrels in reserve

However, last week provided a cautionary signal that the pursuit of the $100 price mark might have gone too far, as Brent crude experienced an 11% drop, settling just below $85 on the ICE Futures Europe exchange. The aggressive production cuts by Saudi Arabia and Russia may have pushed prices to unsustainable levels, heightening concerns about the economy and the potential for increased interest rates.

Conversely, the decision to reduce output to approximately 9 million barrels per day has afforded Riyadh a substantial cushion of unused production capacity that could be swiftly activated in the event of a crisis. Estimates suggest that the Kingdom holds about 3 million barrels per day in reserve, while the neighboring United Arab Emirates Possesses an additional 1 million barrels.

This significant safety net of idle capacity serves as another reason why traders do not anticipate an immediate surge in prices when the markets reopen. Nevertheless, these recent events have the potential to resurrect some of the geopolitical risk premiums that had waned in recent years.

Richard Bronze, the head of geopolitics at consultant Energy Aspects Ltd., observes, “The Hamas strike and Israeli response raise the geopolitical temperature,” underscoring the heightened uncertainty in the region.

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