Escalating Tensions: Iran and Israel’s Military Confrontation
On October 1st, Iran launched missiles at Israel, marking a significant escalation in the ongoing conflict between the two nations. This aggressive move came after Israel’s extensive military operations against Hizbullah and other Iranian proxies. As the world watches intently, questions arise about how Israel will respond and how this might affect global oil markets. Last week alone, crude oil prices surged by 10%, reaching $78 a barrel, their largest weekly increase in almost two years. Market reactions are bracing for potential disruptions, reminiscent of the sharp oil price rise seen during the Russia-Ukraine conflict in 2022, when prices soared past $100. Could we witness a similar crisis unfold once again?
Understanding Israel’s Retaliatory Options
The scale of potential fallout hinges upon Israel’s retaliatory choices. Should Israel focus solely on military targets, such as missile-launch sites, and Iran responds in moderation, the fear premium surrounding oil prices might dissipate. However, if Israel escalates its operations to include attacks on Iranian civilian infrastructure—particularly oil and gas facilities or nuclear enrichment sites—the situation could spiral out of control. In response, Iran might feel compelled to engage in a more aggressive counterattack, potentially making its petro-industrial complex a primary target. Thus, even if oil facilities are not directly attacked, global markets can still react with anxiety.
Key Iranian Oil Assets at Risk
If Israel decides to strike Iran’s oil infrastructure, it might target crucial assets that convert crude oil into petroleum products. One strategic option could be the Abadan refinery, which supplies approximately 13% of Iran’s domestic petrol needs. While such strikes would primarily impact local supply, they could inadvertently lead to an increase in global crude availability by allowing more Iranian crude to be exported.
A more severe approach would involve targeting the oil terminals on Kharg Island in the Persian Gulf, a vital hub from which 90% of Iran’s crude oil exports are shipped. Such a move would not only provoke a diplomatic backlash, particularly from the Biden administration as fuel prices could spike just before America’s presidential election, but also from China, the principal destination for Iranian oil.
Market Dynamics and OPEC+ Response
Even if Israel were to execute a successful strike on Iranian oil facilities, the overall global fallout is expected to be manageable. Unlike previous crises, when demand for oil was at its peak and supply was tight, the current market is characterized by ample supply and sluggish demand. OPEC+ has over 5 million barrels per day of spare capacity, which is more than sufficient to offset any decrease in Iranian crude output. The group has planned to gradually increase oil production by 180,000 barrels per day starting in December, indicating that they are poised to respond to any significant market disruptions.
Additionally, production is on the rise in regions such as the United States, Canada, Guyana, and Brazil, with the International Energy Agency forecasting a 1.5 million barrels per day increase in non-OPEC output next year. This is expected to exceed any potential uptick in global demand. Prior to the latest escalation in the Middle East, analysts were even predicting an oil surplus by 2025, which would drive prices beneath $70 a barrel. Consequently, while a military strike on Kharg Island would shake the markets, a price rise of only $5 to $10 above current levels is anticipated.
The Potential for Wider Conflict
The situation could escalate further if Iran retaliates against Gulf states perceived as aiding Israel. While recent interactions between Iran and neighboring Arab states suggested a move toward stabilization, any sense of stability could easily unravel, prompting Iran to target oilfields in smaller Gulf states like Bahrain or Kuwait.
One of the more drastic measures Iran could consider is closing the Strait of Hormuz, a strategic chokepoint through which approximately 30% of the world’s seaborne crude oil and 20% of its liquid natural gas is transported. This act would be economically self-defeating for Iran, as it would obliterate its export capabilities and create significant unrest with China, among other countries.
Navigating Market Reactions
Predicting market responses to these potential scenarios is complex, especially as each Iranian action could provoke responses from Israel, the United States, and other nations. For instance, both America and China might deploy naval forces to ensure the reopening of the Strait of Hormuz, maintaining the flow of oil. However, if there are substantial and sustained disruptions leading to oil shortages, prices could rise sharply, potentially reaching $130 a barrel—a price point at which demand destruction could occur, curtailing consumption.
Overall, if traders perceive a high likelihood of such geopolitical tensions escalating, current fears would likely be quickly reflected in oil pricing. Despite recent price surges, historical context reveals that oil trading in recent months, with average prices around $82 a barrel last year and $100 in 2022, remains less volatile by comparison. While tensions in the Middle East are rising and have caught many off guard, a return to triple-digit oil prices would require a confluence of adverse events to unfold rapidly and dramatically.
© 2024, The Economist Newspaper Limited. All rights reserved.
From The Economist, published under licence. The original content can be found on www.economist.com
