Markets brace for Middle East oil supply shock

The oil market is reeling after tensions between Israel and Iran flared this week. Fears of an all-out war and a real disruption of oil supplies from the Middle East have intensified, pushing oil prices higher.

As the world awaits Israel’s response to Iran’s missile attack on Israel earlier this week, reports suggest that Israel may target some of Iran’s energy and oil infrastructure.

Unlike similar geopolitical outbursts in the recent past, oil prices remained relatively low for the year following the October 2023 Hamas attack on Israel that triggered the current Middle East crisis.

That’s because OPEC, which is cutting oil production to “stabilize” the market, has an estimated 5 million barrels per day (bpd) of unused production capacity.

Analysts believe OPEC, particularly its Middle Eastern producers Saudi Arabia and the United Arab Emirates (UAE), have enough spare capacity to offset potential supply losses from fellow member Iran.

However, if the conflict escalates to Iranian proxies targeting oil infrastructure in Iran’s Middle Eastern neighbors, or if Iran moves to block or restrict oil cargo traffic in the Strait of Hormuz, oil prices could rise to three figures and could rise to a record, analysts say.

But most observers and experts see the mother of all oil shocks — a closing of the Strait of Hormuz — the world’s most important choke point for oil trade that handles about 20 million barrels per day (bpd) — as a likely event. low.

However, the market is bracing for a real supply disruption from the Middle East a year after the current conflict began.

Related: Oil markets are fully focused on geopolitical risk

If Iran’s infrastructure is targeted, the maximum damage to global oil supplies would be about 3.5 million bpd, of which about 1 million bpd is exports, mostly to China.

Such a disruption is easily within OPEC’s ability to compensate, as it has more than 5 million bpd of spare oil production capacity.

“In theory, if we were to lose all Iranian production – which is not our base case – OPEC+ has enough available capacity to offset the shock,” Amrita Sen, co-founder of consultancy Energy Aspects, told Reuters.

Saudi Arabia could increase its oil production by about 3 million bpd and the United Arab Emirates by 1.4 million bpd, analysts say.

The market has started to price in some form of Israeli attack on Iran’s oil infrastructure, consultancy FGE said in a note on Friday.

Any disruption to Iranian oil supplies is likely to push Brent oil prices above $80 a barrel, but absent that, we could quickly return to $70 a barrel, FGE says.

However, should the conflict escalate, the spare capacity of Middle East producers could be vulnerable to attack, according to UBS analyst Giovanni Staunovo.

“The actual available spare capacity could be much lower if there are renewed attacks on energy infrastructure on countries in the region,” Staunovo told Reuters.

Citigroup considers a possible Israeli attack on Iran’s main oil export facility, Kharg Island, where 90 percent of Iran’s exports come from, to be “low probability, high impact.”

But that could prompt Iran to try to disrupt traffic in the Strait of Hormuz, which will “represent a tipping point for the global oil market and the global economy,” Citi said in a commentary published by MarketWatch.

Such an event could lead to a “significant increase well above previous record highs,” the bank’s analysts noted.

However, others doubt the escalation would be that serious.

“Will the US really allow Israel to blow up oil facilities on its antagonist’s border during an election year? It will effectively close the Strait of Hormuz to Iran, which will not only cut off its neighbors’ exports, but its only notable source. international income?” say the analysts from PMV.

“The extent of the war and its damage will have to be proven before oil market participants shake off the overwhelming presence of skepticism.”

By Tsvetana Paraskova for Oilprice.com

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