Geopolitical Conflicts Drive Oil Prices Up: Risk of Supply Disruptions?

2024-10-04 146 Comments

As investors worry that Iranian oil facilities may become targets for Israeli retaliation, the rising tensions in the Middle East continue to drive a significant increase in international oil prices.

On October 7th, international oil prices closed up by more than 3%, with Brent crude futures breaking the $80 per barrel mark for the first time since August. Brent crude futures rose by 3.7%, settling at $80.93 per barrel; U.S. crude futures also rose by 3.7%, reporting $77.14 per barrel.

Prior to this, last week both Brent and U.S. crude oil recorded a cumulative increase of over 8%, marking the largest single-week rise since March 2023, with the October increase already exceeding 10%.

Li Jie, a senior researcher in energy and chemical engineering at Jianxin Futures, told a reporter from the 21st Century Economic Report that this round of international oil price increases is mainly driven by the geopolitical situation in the Middle East. The region is a major hub for global crude oil supply, and geopolitical risks exert pressure on oil prices.

It should be noted that in recent years, Iran's crude oil production has been steadily increasing, reaching nearly 3.3 million barrels per day in August 2024, a 50% increase since Biden took office. Iran is the third-largest oil-producing country in the Organization of the Petroleum Exporting Countries (OPEC), and it controls the Strait of Hormuz, which had a crude oil traffic volume of over 20 million barrels per day in 2023, accounting for more than 20% of global demand. Li Jie warned that if the situation in the Middle East continues to escalate and transportation routes are obstructed, major oil-importing countries in Europe and Asia will have to seek alternative supply sources, increasing procurement costs and leading to a sustained rise in global oil prices.

Advertisement

Although the market has already begun to speculate about oil prices reaching $100 per barrel, there are uncertainties about whether oil prices will soar next, with the direction of the Middle East situation being crucial. Will Israel strike Iranian oil facilities? What is the risk of the Strait of Hormuz being interrupted? Is OPEC willing to release idle production capacity? These questions still await answers.

Supply disruption risks emerge

According to CCTV news, after Iran launched a large-scale missile attack on Israel on October 1st, Israel vowed to retaliate, indicating that it might target Iranian oil facilities. On the 8th, local time, informed sources in the Iranian military revealed that the Iranian military has prepared "at least ten plans" to deal with possible military actions by Israel.

It should be noted that the market has always been "immune" to geopolitical risk factors, believing that there is no risk to crude oil supply. However, the recent sudden escalation of tensions in the Middle East has brought the risk of supply disruption to the forefront.Senior economist in the oil industry, Zhu Runmin, analyzed to the 21st Century Economic Report that at the beginning of October, Iran fired hundreds of ballistic missiles at targets within Israel, and Israel declared that it would retaliate. Although the retaliation has not yet been implemented, Israel has intensified its strikes against Hezbollah in Lebanon. The geopolitical situation in the Middle East shows a further escalating trend, and Iranian oil facilities may become an important target for Israeli retaliation. If Israel carries out strikes on Iranian oil facilities, causing a large-scale shutdown of Iran's oil production, processing, and export facilities, millions or even tens of millions of barrels of oil supply will be impacted daily.

In extreme cases, Zhu Runmin analyzed that if a large-scale conflict breaks out between Israel and Iran, the Strait of Hormuz, an important throat of international oil shipping, may be closed. If this happens, it will lead to the interruption of tens of millions of barrels of oil shipping daily, and many countries and regions that rely on the Strait of Hormuz to import oil will face severe supply problems. At that time, the international crude oil price will no longer be a matter of $80/barrel or $90/barrel. A new round of international crude oil price surge may be initiated in advance.

The Strait of Hormuz is the most important energy channel in the world, with more than one-fifth of the world's oil supply passing through this narrow maritime channel. This channel is used by Gulf countries such as Iran, Saudi Arabia, and the UAE, and is a strategic shipping route connecting Middle Eastern crude oil-producing countries with the world's major markets.

Alan Gelder, Vice President of Wood Mackenzie's oil market, said that the market is currently only pricing the possibility of Israel attacking Iranian oil facilities, but this is not the worst-case scenario. The worst-case scenario is interference in the Strait of Hormuz, which will have a more drastic impact on crude oil prices.

The impact of the Middle East situation remains uncertain.

For international oil prices, the direction of the Middle East conflict in the future is crucial, and the impact remains to be observed.

If there is no substantial impact on future Middle East crude oil supply, there is a risk of oil price correction. Zhu Runmin analyzed that if Israel's retaliation against Iran is not as serious as the market imagines, and it does not cause significant damage to Iranian oil facilities, and the two countries announce a temporary end to the counterattack after taking action as before, then international crude oil prices may fall rapidly.

Han Zhengji, a crude oil analyst at Jinlian Chuang, told the 21st Century Economic Report that in the short term, as market concerns ease, there is a risk of oil price correction. However, overall, the geopolitical situation still supports oil prices. The Israeli-Palestinian conflict has been going on for a year, and not only has the negotiation not made substantial progress, but the situation between Lebanon and Israel and between Iran and Israel is also tense. It is difficult for the Middle East situation to stabilize in the short term. Even if crude oil supply is not impacted, market concerns cannot be completely eliminated before the actual stability of the Middle East situation, which will support oil prices.

If Middle East crude oil supply is impacted, there is still room for international oil prices to continue to rise. Goldman Sachs believes that if Iranian oil supply is affected, Brent crude oil prices may reach $90/barrel or higher, and the specific price impact depends on whether other OPEC member countries increase production to compensate. If Iran's supply is reduced by 1 million barrels/day, and OPEC takes action to fill the supply gap, Brent crude oil prices may rise to around $85/barrel, and in the absence of measures, Brent crude oil prices will reach a peak of around $95/barrel.Zhu Runmin analyzed that the future oil prices largely depend on the restraint and degree of conflict between Israel and Iran. If it does not escalate into a local war and does not lead to the closure of the Strait of Hormuz, the impact will be relatively weak. Even if Iran's supply to the international oil market is interrupted, the impact would only be around 1 million barrels per day, and the upward space for international crude oil prices is limited, potentially climbing to around $90 per barrel.

OPEC's spare production capacity is an important force in balancing the oil market. Claudio Galimberti, Chief Economist at Rystad Energy, stated that as conflicts in the Middle East intensify, the risk of oil supply disruptions is increasing. However, OPEC has a large amount of spare production capacity that can fill potential supply gaps. "In the face of the most severe and widespread crisis in the Middle East in forty years, these spare capacities will prevent oil prices from getting out of control."

Nevertheless, there is still uncertainty about whether OPEC's spare production capacity will be significantly brought online. Han Zhengji analyzed that for OPEC, its spare production capacity can indeed act as a buffer. However, countries like Saudi Arabia have a demand for high oil prices. If oil prices rise, it aligns with their interests, and then OPEC's production policy may not undergo significant adjustments.

In the extreme case of the closure of the Strait of Hormuz, OPEC's spare production capacity may not be effective. Bob McNally, President of Rapidan Energy and former White House energy advisor, warned that once there is a serious disruption in the Persian Gulf, these oil supplies will be meaningless. "Spare capacity will not help because most of this oil will be trapped within the Strait of Hormuz."

How will international oil prices evolve?

Boosted by geopolitical factors, international oil prices in the fourth quarter have changed from their previous downward trend. However, with a mix of bullish and bearish factors, there is still uncertainty about future oil prices.

Han Zhengji analyzed that, generally speaking, the fourth quarter is usually the off-season for crude oil consumption. During this period, global oil demand will gradually shrink, and crude oil prices will also fall. However, this year's crude oil market may have a chance to rebound.

From the demand side, seasonal cooling of oil demand will occur. From the supply side, to avoid further decline in oil prices, OPEC+ has postponed the resumption of additional production cuts to December, which limits the total supply of crude oil. In addition, as the Federal Reserve enters a rate-cutting cycle, it will, on the one hand, suppress the US dollar exchange rate, and on the other hand, reduce loan costs and promote economic development, thereby boosting crude oil demand and prices.

Middle East geopolitics and the US election are the main sources of uncertainty. Once geopolitical tensions escalate, they will inevitably push up crude oil prices in the short term, and vice versa. The next US president's energy-related policies will also affect the crude oil supply and demand pattern in the coming years.Overall, the future outlook for the oil market is somewhat optimistic. From the supply side, there were earlier market reports suggesting that Saudi Arabia might abandon production cuts to secure market share. However, Li Jie cautions that Saudi Arabia has a strong desire for higher oil prices, and the United States currently lacks the ability to significantly increase production. OPEC+ can still support oil prices by proactively reducing production. In the current market environment, Saudi Arabia's primary strategy remains to sacrifice market share to ensure oil prices. If oil prices drop significantly again before the production increase in December, it is highly likely that Saudi Arabia will reduce production on its own or collaborate with other member countries to jointly control supply.

As the demand side approaches the transition from the off-season to the peak season, this year's peak season terminal demand has been lower than market expectations. However, China has recently introduced a series of stimulus policies that support crude oil and other commodity prices in the short term. Both the balance sheets from the U.S. Energy Information Administration and the International Energy Agency indicate that the market will continue to destock in the third quarter of this year, with the destock rate narrowing in the fourth quarter. Overall, the latest monthly reports from the three major agencies do not significantly downgrade the demand side. The market is expected to continue destocking in the fourth quarter, coupled with the recent escalation of geopolitical tensions in the Middle East, it is anticipated that oil prices will continue to fluctuate at high levels in the short term.

Leave A Comment