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Geopolitics
MIDEAST TENSIONS AND RISK PREMIUM PART WAYS
Copyright © 2024 Energy Intelligence Group All rights reserved. Unauthorized
access or electronic forwarding, even for internal use, is prohibited.
Published:
Thu, Aug 8, 2024
Author
Frans Koster, New York
Editor
Jill Junnola
Change_activist/Shutterstock
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Even as tensions escalate in the Middle East and Iran seems poised to strike
Israel again, oil prices appear to have almost no risk premium whatsoever.
Global benchmark Brent is well below the $80 per barrel mark, continuing to
trend lower than it was prior to Hamas’ Oct. 7 attack on Israel that started the
current round of violence. Market players and experts say the lack of risk
premium reflects new realities, both for oil itself and more broadly in
geopolitics. However, the fact remains: Israel and Iran appear on the cusp of
open hostilities that could disrupt oil supply and directly embroil major crude
producers. Is the market getting complacent?
* The oil market is betting that the latest round of escalation will follow a
familiar script that does not involve supply disruptions, with the timing
also coinciding with a souring macroeconomic environment and growing fears
over demand.
Iran has signaled its intention to strike Israel following last week's
assassination of Hamas political leader Ismail Haniyeh in Tehran and killing of
Hezbollah senior commander Fouad Shukur in Beirut. Israel has vowed a strong
response. Yet, the risk premium in oil is either low or nonexistent, according
to traders. One market source said that in the past, just the prospect of war
between Iran and Israel would have put at least $10 per barrel into oil, and
that current risk assessments are “laughably low.”
But there are compelling reasons for this perceived complacency. Although the
current iteration of conflict in the Middle East has dragged on for 10 months,
“for all intents and purposes, there has been no oil supply disruption,” said
Andy Lipow, of Lipow Oil Associates. Instead, Houthi attacks in the Red Sea have
affected shipping, to which oil flows have adjusted and which traders have
already priced in. “This has dragged on for quite some time and people are not
sure if any disruptions will follow through,” said Carl Larry, vice president of
energy clearing at UK-based financial firm Marex. Another market source likened
the situation to the proverbial boy who cried wolf.
Fundamentals provide a headwind to higher prices, too. Liquids production in the
US is at a record high and rising, alongside volumes from other non-Opec-plus
players such as Canada, Brazil and Guyana. Meanwhile, spare capacity would seem
to provide a massive cushion. Ongoing voluntary Opec-plus cuts alone constitute
some 2.2 million barrels per day that could be brought on line relatively
quickly. Global spare capacity sits at a whopping 7.26 million b/d, according to
Energy Intelligence.
Demand and macroeconomic concerns also play a role. Just this week, markets
flirted with the notion of an impending recession in the US, still the world’s
largest economy and oil consumer. Demand in China — seen as underpinning the
bulk of incremental consumption, with China also the main importer of sanctioned
Iranian crude — continues to throw up warnings signs in the form of lower
refinery utilization and overall crude imports.
* New political realities and recent events are keeping a lid on risk premium,
too.
It has not escaped the market’s notice that the current Iranian threats and
Israeli rhetoric are so far following a familiar script. In April, the world
braced for Iran’s telegraphed missile attack on Israel. It landed with not much
of a bang — virtually all drones and missiles were shot down by Israel, the US
and even Jordan. Israel did not respond in a way that disrupted supply. Iran is
again telegraphing its intentions ahead of time, issuing warnings to commercial
flights to avoid airspace and publicly talking of the need to punish and create
deterrence for Israel while vocally tamping down the prospects of a broader war.
This reflects broader geopolitical shifts. A thawing in relations between Iran
and Saudi Arabia is under way following last year's China-brokered restoration
of diplomatic ties, and markets are betting this means Iran, or its proxies, are
unlikely to interfere with the Strait of Hormuz, a key waterway for some 13
million b/d of crude and 5 million b/d of product exports to the world. Further,
the prospect of Gulf Arab states using oil as a political tool to effect change
in this conflict also seems nonexistent at the moment. “I think there is a
certain degree of understanding and perspective that it's in nobody in the
region's interest [to] put the cork in the bottle,” said Albert Helmig, of
private consulting firm Greyhouse, referring to blocking the Strait of Hormuz.
As for Israel, market and political sources speculate it is under heavy pressure
from its allies — and especially the US — not to act in a way that could disrupt
oil supplies. Higher crude prices in the midst of a contentious US election
campaign are far from welcome, after all.
* Escalation is still possible, and prices could rise swiftly, but markets seem
to be looking not at Iran, but at Israel’s response as the catalyst.
There is a degree of certainty on Iran’s actions based on recent rhetoric and
warnings. But Israel sees Iran and its allies as an existential threat, while
Prime Minister Benjamin Netanyahu’s political future is intimately tied to the
ongoing war and he has repeatedly bucked pressure from Washington. This makes
Israel's response less clear, especially if an Iranian strike results in
significant damage or loss of life. “If Iran hits Israel and Israel sends a much
stronger reaction back, then it might get out of hand. It’s about the second
move. It’s about the Israeli response — if there is one — and how big it would
be,” said Larry.
A significant escalation and disruption to oil supply would yield a likely
$5-$10/bbl pop in prices immediately, sources suggested. High frequency and
algorithmic trading allows for a quicker reaction, and financial positioning
means market players would need to quickly take a lot of long positions in order
to benefit from any such attack. Other players could just decide to not be
exposed to political jostling and sit on the fence.
*
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Topics:
Military Conflict, Opec/Opec-Plus, Macroeconomics, Oil Supply, Opec-Plus Supply,
Oil Demand, Non-Opec Supply
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