Despite Iran’s attack on Israel over the weekend, oil prices dropped on Monday as an Iranian response to the Israeli hit on the Iranian diplomatic mission in Syria was largely expected and priced in.
The well-telegraphed-in-advance Iranian drone attack against Israel may have been peak escalation, for now, analysts and investment banks say.
However, uncertainty over a potential Israeli retaliation and whether restraint will prevail continue to keep the oil market on edge. Risk premiums and fear will continue to be priced in Brent Crude for the foreseeable future.
Uncertainty and risks have grown in the Middle East – a key oil-producing region, which is also home to the world’s most crucial oil chokepoint, the Strait of Hormuz. About 21 million barrels per day (bpd), or a fifth of the world’s daily consumption, is being transported out of the top Middle Eastern exporters via the Strait of Hormuz.
‘Well Above $100’
In case of further escalation, $100 oil is possible, analysts say, especially if this involves direct threats to oil supply.
“What is not priced into the current market, in our view, is a potential continuation of a direct conflict between Iran and Israel, which we estimate could see oil prices trade up to +$100/bbl, depending on the nature of the events,” Citigroup in a note, as carried by Bloomberg.
The worst-case scenario for oil supply is Iran attempting to disrupt tanker traffic in the Strait of Hormuz, which could send oil prices spiking to $130 per barrel, according to Lipow Oil Associates. Related: China’s Crude Oil Imports Hit A Record High in 2023
“Any attack on oil production or export facilities in Iran would drive the price of Brent crude oil to $100, and the closure of the Strait of Hormuz would lead to prices in the $120 to $130 range,” Andy Lipow, president of Lipow Oil Associates, told CNBC.
An escalation involving the U.S. could send oil surging to $140 per barrel, according to Societe Generale, which has raised its Brent price forecast by $10 a barrel to reflect continued geopolitical risk premium.
Escalation Not the Base-Case Scenario
While warning that oil prices could spike well above $100 per barrel in case of a major escalation, investment banks do not consider such escalation the base-case scenario.
While Israel is weighing its response to the Iranian attack, the G7 has called for restraint and the U.S. has signaled it wouldn’t be part of any Israel offensive against Iran.
U.S. President Joe Biden has assured Israeli Prime Minister Benjamin Netanyahu that the U.S. commitment to defend Israel is “ironclad,” but the U.S. would not participate in an offensive against Iran, a senior administration official has told NBC News.
As of early Tuesday, Israel was still weighing its options.
Iran has signaled that with the drone barrage against Israel it considers the matter closed, the permanent mission of Iran to the United Nations said on Sunday, but added that “should the Israeli regime make another mistake, Iran’s response will be considerably more severe. It is a conflict between Iran and the rogue Israeli regime, from which the U.S. MUST STAY AWAY!”
In view of calls on Israel for restraint, the “most likely path from here (to be) de-escalation rather than further escalation,” Richard Bronze, co-founder and analyst at Energy Aspects, told CNN.
“While Israel’s allies are pushing for a diplomatic response, it appears for now that Israel is considering a more direct response. If this is the case, it unfortunately means that this uncertainty and tension will linger for quite some time, as markets will then focus on how Iran further retaliates,” ING strategists Warren Patterson and Ewa Manthey wrote in a Tuesday note.
“Iranian oil output is most at risk and even a strong diplomatic response from Israel’s allies could hit Iranian oil exports significantly with stricter enforcement of oil sanctions,” say the strategists, who see up to 1 million barrels per day (bpd) of Iranian oil off the market in such case.
‘The Worst Has Passed’
Morningstar sees “more downside risks than upside at the moment,” Stephen Ellis, an energy and utilities strategist for Morningstar, wrote on Monday.
“[T]he ample public and private forewarning from Iran amid rising regional tensions means the attack was already reflected in oil prices via a higher geopolitical risk premium.”
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Most of the recent rise to $91 oil before the Iranian attack has been the result of geopolitical risks rather than supply risks, according to Morningstar, which notes that the OPEC+ group has ample spare capacity of about 5 million bpd – and probably more – part of which it can return to the market if oil prices surge above $100.
“We expect more downside risks than upside at the moment, and see a higher potential to touch $75 by the end of 2024 versus a sustained movement beyond $100 a barrel,” Morningstar’s Ellis said.
Iran’s retaliation can now prompt profit taking and prices could be easing, but this is not the end of risk premiums, consultancy FGE said in a note on Monday.
Despite pressure from allies on Israel to limit a possible response, further escalation is not entirely off the cards, but FGE says that “Our base case is that the worst has passed.”
FGE’s base case is now for OPEC+ to decide to unwind some of the production cuts as of July.
Even with another up to 1 million bpd from OPEC+ output back on the market, Brent is still expected to average $90-$95 a barrel in the third quarter with the ongoing political risk, the consultancy said.
By Tsvetana Paraskova for Oilprice.com
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However, it could push inflation higher in the stagnating economies of the United States and the EU but won't affect the China-led Asia-Pacific countries where economic growth is fast and inflation at its lowest rates.
Bren crude is headed this year towards $90-$100 a barrel underpinned by solid fundamentals, robust demand, a tight market and record-breaking Chinese crude imports. If geopolitical tension escalate sharply in the Middle East causing a disruption in oil supplies, Brent could surge higher than $100 and could even hit $110-$120 for a short period.
Dr Mamdouh G Salameh
International Oil Economist
Global Energy Expert