Fierce fighting is underway in a region that contains much of the world’s petroleum resources. But after a few days of concern following the bloody raids by Hamas militants in Israel on October 7, energy markets are collapsing. Brent crude, the international oil benchmark, is currently selling for about $80 a barrel, cheaper than when the fighting began.
Why aren’t the prices higher? A key reason, analysts say, is that the fighting, however intense, has caused little disruption to oil supplies, leading traders to conclude there is no imminent threat.
“While traders recognize there is increased risk, this has not led to much precautionary buying,” said Richard Bronze, head of geopolitics at Energy Aspects, a London-based market research firm.
Looking at the Middle East, “markets are effectively rejecting that anything could go wrong,” said Raad Alkadiri, managing director of energy and climate at Eurasia Group, a political risk firm.
Mr Alkadiri said traders were unlikely to increase prices unless they saw “actual barrels” being withdrawn from the market.
Focus on declining demand
The market appears to have turned a blind eye to the war and returned to a pessimistic mood about future oil demand, dominated by economic concerns about China, the largest oil importer, and other major consumers. Saudi Arabia and other producers have tried to support prices by reducing their oil production.
Forecasters warn that 2024 could be a difficult year in oil markets. The U.S. Energy Information Administration predicted this week that gasoline consumption in the United States will decline next year as fewer people commute, more people work on hybrid schedules, more efficient vehicle engines become available and the number of electric cars increases.
The bearish sentiment weighed heavily on prices ahead of the Israel-Hamas conflict and appears to be weighing on the market again, despite the risks of a major war.
Haves and have-nots
As the fighting continues, traders have discovered that there are haves and have-nots when it comes to oil in the Middle East. Gaza produces no oil and Israel produces little. For there to be a significant supply disruption, the effects of the war would have to spread to the vast oil fields of Saudi Arabia, Iraq or Iran.
At the start of the conflict, Iran’s foreign minister called for an oil embargo against Israel, evoking memories of the oil embargo of 50 years ago. But times have changed: given concerns about the role fossil fuels play in climate change and their dependence on oil for income, such a move would backfire for the countries that have imposed such a ban. Iran would risk angering China, the Islamic Republic’s most important customer.
“It is very unlikely that supply risk comes from an independent decision to restrict oil sales by Iran or OPEC,” Eurasia Group said in a recent note. “Any such move would cause as great – if not greater – harm to producers as it does to consumers.”
The remaining risks
A disruption is not unthinkable. Four years ago, a missile attack on a key Saudi facility that American officials blamed on Iran temporarily reduced about half of the kingdom’s oil production.
In extreme cases, Iran, Hamas’s main backer, could try to block the Strait of Hormuz, through which huge amounts of oil flow to the rest of the world. “I still think there is significant risk of this spreading,” said Helima Croft, head of commodities at RBC Capital Markets, an investment bank.
Ms. Croft attributes the apparent complacency over the impact of the war in part to traders losing money when prices rose above $120 a barrel after Russia’s invasion of Ukraine but then quickly fell.
“The market simply doesn’t have the attention span for topics like this anymore,” she said.
Ms. Croft, a former Central Intelligence Agency analyst, said the apparent success of the early days, the invasion of Iraq by U.S. forces in 2003, eventually led to a conflict that dragged on for years. “We could still have a nasty surprise in the Middle East,” she said.
The Biden administration is actively trying to prevent the war from expanding. Regional oil powers, including Iran, would also prefer to maintain tanker traffic through the Persian Gulf. Any stops would reduce their own export earnings, while price spikes risk harming and alienating their most valuable customers.
“It is likely that the conflict will remain contained and not spill over into the region’s major oil producers or key shipping routes,” said Energy Aspects’ Mr Bronze. “The risks come more from miscalculations and misjudgments,” he added.