Is the Middle East on the brink of an ‘oil war’?

Israel is considering attacks on Iran’s energy sector, an option for retaliation that has rattled markets and raised fears that war in the Middle East could threaten global oil supplies.

Any Israeli attack that would disrupt Tehran’s 1.7 million barrels per day of oil exports would have ramifications for global energy markets – while any Iranian retaliation targeting rival Middle Eastern oil exporters would cause further turmoil .

Such an unchecked cycle of attacks would risk a spike in the prices of the world’s most essential commodity, reigniting inflation and damaging the global economy weeks before the US election, analysts said. But they said there are mitigating factors that point to some underlying market resistance.

Will Israel Strike Iran’s Energy Infrastructure?

Israel has discussed strikes against Iran’s oil and gas industry with its US allies as it considers a potential response to Tehran’s firing of 180 missiles at Israel this week.

When Iran launched a clearly telegraphed missile and drone attack on Israel in April, Prime Minister Benjamin Netanyahu’s government responded with a strike on an Iranian airbase. Neither side sought further escalation.

This time, however, analysts are predicting a more aggressive Israeli response that could target Iran’s key oil and gas industry.

“Israel is in what I call ‘three eyes for one eye’ mode.” I have a feeling the response will be much bigger than in April,” said Bob McNally, founder of Rapidan Energy Group and former energy adviser to US President George W Bush.

Washington is expected to urge Israel to limit its attacks on Iran’s energy infrastructure. But Israel sees the energy sector as “the ATM for the axis of resistance proxies,” said Helima Croft, head of commodities strategy at RBC Capital Markets and a former CIA analyst, referring to the network of Iran-backed militant groups in the region .

What sites could Israel target in Iran?

The Islamic republic’s most important piece of energy infrastructure is the export facility on Kharg Island, about 25 km off Iran’s southern coast, which handles about 90 percent of its crude oil shipments.

“There is a big risk of concentration for Iran on Kharg Island, which is essentially the nerve system of the Iranian oil sector,” Croft said.

Empty tankers near Kharg have fled the area since Iran’s missile attack on Israel, said Samir Madani, chief executive of TankerTrackers.com, which reports on oil shipments.

He said Iran’s national tank group “seems to fear an imminent attack by Israel”, adding that such an “overnight evacuation” had not been seen before.

During the Iran-Iraq war in the 1980s, Baghdad threatened to destroy the Kharg facility and targeted tankers leaving the terminal.

Alternative, less significant energy targets could include the Abadan refinery — which accounts for 17 percent of Iran’s refining capacity and 13 percent of its gasoline supply, according to analysts at Kpler — and the Mahshahr oil terminal. Major pipelines and storage facilities near Hormozgan could also be targeted.

An Israeli strike against Iran’s minor oil infrastructure could cause a temporary output loss of up to 450,000 bpd, Citi estimates. But an attack on Kharg would result in a much larger and more prolonged loss of up to 1.5 million b/d, or about 1.4% of global consumption.

Hitting refineries rather than oil fields or export terminals could have less of an impact on oil prices or even send them lower because Iran would have more crude to sell abroad.

What might Iran do in response?

In retaliation, Iran and its proxies could seek to internationalize the conflict by striking energy operations throughout the region, including operations by US companies or US allies in the Gulf. Any such move, analysts warned, would represent a significant escalation.

“The risk is that this will no longer be a limited conflict between Israel and Iran. Now there’s a wide arc of uncertainty,” said Daniel Yergin, a Pulitzer Prize-winning energy historian. “It could be breasts for tattoos. The danger is breasts and tattoos could get much bigger.”

In 2019, the US blamed Iran for a sophisticated missile and drone attack on Saudi Arabia’s Khurais and Abqaiq oil facilities that temporarily knocked out more than half of the kingdom’s crude oil production. Iran was also blamed for two sabotage attacks on tanks in the Gulf that year.

But a rapprochement since Riyadh and Tehran restored diplomatic ties last year means Saudi Arabia is now unlikely to be “at the top of the list of Iranian retaliatory strikes,” RBC’s Croft said. The two countries have been in constant contact since the October 7 Hamas attack on Israel sparked a wave of regional hostilities.

Iran could instead push its proxies to step up attacks on oil tankers, cutting off supplies and forcing traffic to be diverted. Yemen’s Houthi rebels have been attacking merchant ships in the Red Sea for months, saying the attacks are in support of Hamas and the Palestinians.

A “more extreme” scenario, said Jason Bordoff, founding director of Columbia University’s Center for Global Energy Policy, would be to shut down traffic through the Strait of Hormuz, the shipping lane through which one in five barrels of global crude oil consumption passes. day.

During the Iran-Iraq war of the 1980s, Tehran mined the strait in what became known as the tank wars.

In April, when it launched its first direct military strikes on Israel from Iranian soil in retaliation for an Israeli attack on its Syrian embassy compound, it seized a ship there. But despite threats from hardliners during periods of high tension, Iran has never blocked traffic through the strait.

Any effort to close the strait would hurt Iran’s own exports, which analysts say makes it unlikely. “I think this is a low-probability event that would be difficult to implement even if Iran wanted to,” Bordoff said.

What would be the impact on oil prices?

This week’s events jolted markets out of relative calm, with sluggish demand from China weighing on prices. Brent crude, the global benchmark, rose 8% this week to nearly $78 a barrel.

If the standoff remains limited to limited airstrikes that do not hit energy infrastructure, Brent prices are unlikely to rise above $85 a barrel, Eurasia Group’s Henning Gloystein said.

But successful Israeli strikes against Iranian oil assets will “almost certainly push prices above $85 a barrel and possibly to $100,” he said. “Only if there is then major Iranian retaliation that would seriously impact shipping through Hormuz could Brent go much higher.”

Analysts at Citi said a successful effort to choke off the Strait of Hormuz, while unlikely, would push prices “well above previous record highs,” if only for a limited period. Brent’s all-time high was $147.50 a barrel in 2008.

Any increase in crude oil prices will eventually feed through to gasoline costs, which could affect November’s US presidential election. Rising prices may be a liability for the current Democratic Party.

What could stabilize the market?

Countering forces that were absent during previous conflicts should help keep prices under control if fighting intensifies.

Two years of output cuts by OPEC+ producers – notably Saudi Arabia and the United Arab Emirates – mean the group has more than 5 million barrels per day of spare capacity that could be brought back in if Iranian supplies were suddenly cut.

“It’s a reassuring cushion to have in the market as we enter this very dangerous situation,” said Ann-Louise Hittle, vice president of oil markets at Wood Mackenzie.

Western nations also hold significant strategic reserves that could be used to cushion a price spike, after stocks were built up following price shocks in the 1970s.

A US-led briefing following Russia’s full-scale invasion of Ukraine helped lower prices in 2022. But US stocks are now at their lowest level since the 1980s.

China, the destination for almost all of Iran’s oil, has built up its reserves, which could help mitigate any supply disruption.

The prolific U.S. shale patch also provides a buffer drillers, in theory, can ramp up production quickly to drive down prices. But their Wall Street owners will no longer tolerate expensive new drilling campaigns.

“We’re beyond that period,” said Steve Pruett, chief executive of Texas-based Elevation Resources and head of the Independent Petroleum Association of America. “The capital markets imposed a discipline, and the leaders of these companies accepted that discipline.”