Geopolitical tensions have been a constant presence in the oil market, particularly in the Middle East. This past month has been a prime example of how these tensions can cause oil prices to fluctuate, but also how underlying market fundamentals can act as shock absorbers, preventing a major price surge.
The Geopolitical Risk Premium in Oil Prices
Analysts estimate that currently, oil prices include a premium of $5 to $10 per barrel to reflect the potential for escalation in the ongoing conflict between Israel and Iran. This highlights the impact of geopolitical risk on the market. Just after the Iranian drone attack on Israel in mid-April, Brent Crude prices dipped to the upper $80s. However, these prices spiked by 3% early on April 19th following reports of an Israeli missile strike in Iran.
These price fluctuations demonstrate how traders are constantly assessing the potential for escalation or de-escalation in the conflict. However, there are factors at play that are dampening the full impact of these tensions.
Market Fundamentals: Shock Absorbers for Oil Prices
According to Reuters market analyst John Kemp, the current state of the oil market offers a few buffers against price spikes caused by geopolitical tensions. Unless there are direct threats to oil production and exports from the Middle East, the market is expected to be able to absorb a decrease in Iranian oil supply, whether due to stricter U.S. sanctions or disruptions to Iran’s oil production capabilities.
The reassuring factor here is the absence of any immediate threats to oil supply from the region despite the reported Israeli missile strike. Furthermore, the oil market is currently in a unique position with the highest spare capacity in years, along with a recent build-up of commercial stocks. This strong buffer should help offset some of the geopolitical risks that have lingered since the Hamas attack on Israel last October.
OPEC+ and the Spare Capacity Advantage: A Buffer for Oil Prices
Analysts estimate that OPEC+, which holds significant sway over the global oil market, possesses a spare capacity of about 5 million barrels per day (bpd) of oil production. This spare capacity can be gradually reintroduced to the market in the event of severe tightness and a surge in oil prices above $100 per barrel. This represents the highest spare capacity for OPEC since the 2009 recession, excluding 2020 when the pandemic drastically reduced oil demand and global producers withheld a staggering 10 million bpd from the market.
By strategically releasing some of the withheld 2 million bpd supply, OPEC+ can exert a significant influence on oil prices. However, a critical caveat exists – a complete blockade of the Strait of Hormuz, a crucial shipping lane for oil tankers, would cripple oil exports from all Middle Eastern producers, including Iran. While analysts consider this a low-probability event, it serves as a stark reminder of the potential for a major disruption.
The Balancing Act: Geopolitical Risk vs. Market Realities
JP Morgan analysts predict that oil prices will likely continue to reflect some geopolitical risk premium in the coming months. However, a significant escalation would be needed to trigger a price spike comparable to the 2022 highs of $125 per barrel, considering the current market situation at around $90 per barrel.
Related: World Watches: What will Israel’s Response to Iran’s Missile Attack?
New Update: Escalation in Iran-Israel Conflict
Another factor acting as a drag on prices is the recent trend of commercial stock builds. While U.S. commercial stocks are still slightly below the five-year average for this time of year, there has been a noticeable increase in stockpiles this month. This includes inventory builds of 5.8 million barrels and 2.7 million barrels for the weeks ending April 5th and 12th, respectively, according to EIA estimates.
U.S. crude oil stocks have reached a ten-month high, raising concerns about current demand levels. Consultancy FGE further emphasizes this bearish trend, noting that the current build so far this month surpasses the five-year average build in April by more than 13 million barrels. They also highlight a significant year-on-year increase, with total US commercial crude and product stocks currently 3 million barrels higher than a year ago, compared to a 40 million barrel deficit in mid-March.
Conclusion: Cushioning the Blow for Oil Prices
The high spare capacity of OPEC+, recent stock builds in major markets, and anticipated increases in non-OPEC+ production this year are all likely to cushion the price impact of the ongoing Middle East tensions. In the absence of a real disruption to oil supply, these market fundamentals may very well prevent oil prices from breaching the $100 per barrel mark.
Sources:
- OilPrice.com: https://oilprice.com/
- Reuters: https://www.reuters.com/
- JP Morgan: https://www.jpmorganchase.com/
- Energy Information Administration (EIA): https://www.eia.gov/
- Saxo Bank: https://www.home.saxo/
- FGE: https://www.fgenergy.com/
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