Why oil is down since the Hamas-Israel conflict started and whether that can last

Oil prices have fallen to three-month lows as global energy markets largely dismiss fears of a near-term risk that the Israel-Hamas war could escalate into broader regional conflict that causes a major disruption to crude supply.

Brent crude futures and West Texas Intermediate slid to their lowest levels since July on Tuesday. The global benchmark fell $US3.57, or 4.2 per cent, to $US81.61 a barrel, while US crude dropped $US3.45, or 4.3 per cent, to $US77.37.

Oil continued to hover at those lows overnight Wednesday in the US.

Crude prices had spiked more than 9 per cent in mid-October following Hamas’ terrorist attacks and Israel’s retaliatory strikes, but subsequently tumbled even as the Netanyahu government deepened its ground offensive in Gaza.

The fall in prices has been surprising given that war has already turned into a regional conflict, Marko Papic, chief strategist at the Clocktower Group, wrote in a research note this week.

The Houthis in Yemen and Hezbollah in Lebanon, who are backed by Iran, have attacked Israel. And the Netanyahu government has launched strikes in Lebanon and Syria.

A risk premium should be present somewhere in oil prices, Papic wrote.

Slowing global economy?

But concern that the global economy is slowing under the weight of high interest rates appears to be weighing more on prices at the moment than the fear of a broader war in the Middle East.

“If the Hamas attack leads to a regional conflict in the world’s most important oil producing geography, then oil prices should catch a bid… any bid. They have not,” Papic wrote.

“If anything, oil may be thumbing its nose at the slew of geopolitical tourists clamoring for a Middle East War and, instead, predicting that a significant global growth slowdown is afoot,” he wrote.

Oil’s three-month low came after China reported weak economic data and forecasts for US crude consumption dropped precipitously on Tuesday.

Beijing’s crude oil imports rose in October, but the country’s overall exports fell more than expected, indicating the global economy may be slowing. China reported a 6.4 per cent drop in exports in US dollar terms for October compared to the same period a year ago, worse than the 3.3 per cent expected.

It was the six month in a row that China’s exports have fallen as high interest rates in the US and Europe weigh on global demand.

And the US Energy Information now predicts that total US petroleum consumption will drop by 300,000 barrels per day in 2023, after previously forecasting an annual increase of 100,000 bpd.

“The Chinese economic outlook and oil demand is a huge influential issue here,” said Ellen Wald, president of Transversal Consulting. Wald cautioned that the geopolitical risk in the Middle East has not completely evaporated but instead has shifted from an immediate to a medium-term concern.

There is still upside to oil prices despite the recent slide with crude expected to rise again to $US90 to $US100 per barrel, according to a research note from UBS published Wednesday.

Saudi Arabia and Russia confirmed Sunday that they are maintaining production cuts of 1 million barrels per day and 300,000 per day respectively through at least the end of the year. UBS believes these cuts will extend into the first quarter of 2024 to balance seasonally weaker oil demand.

And crude consumption remains well supported despite the lackluster forecast in the U.S., according to UBS. China’s oil imports rose 13.5 per cent year on year, and OPEC expects demand to grow by 2 million bpd next year.

And the risk of supply disruptions from the Israel-Hamas war has not gone away, according to UBS. The biggest risk for oil prices is a decline in Iranian oil exports by 300,000 to 500,000 barrels per day, the bank cautioned. The US House of Representatives last week passed a bill to harden sanctions on Tehran’s crude exports in an overwhelming bipartisan vote following the Hamas’ attacks.

Regional war possible, but unlikely

And the longer Israel’s military campaign to destroy Hamas takes, the greater the likelihood that Iran – the principal backer of Hamas – could create disruption in the Strait of Hormuz, Wald said. Some 30 per cent of the world’s seaborne oil trade passes through the strait.

Iran’s Supreme Leader Ayatollah Ali Khamenei last week called on Islamic crude producers to impose an oil embargo on Israel.

The World Bank has warned that an escalation of conflict in the Middle East on top of disruptions caused by Russia’s invasion of Ukraine could push commodity markets in “uncharted waters”.

Oil prices would rise to $US140 and $US157 per barrel if supply is disrupted on a scale comparable to the 1973 embargo, when Arab producers halted crude exports to the U.S. and other nations that backed Israel during the Yom Kippur war, according to the World Bank.

But an oil embargo or an attempt by Iran to block the Strait of Hormuz are unlikely in the current environment, according to market analysts.

Saudi Arabia and other Gulf Arab oil producers are adversaries of Iran and have little incentive slash production over the Israel-Hamas war. The head of the Gulf Cooperation Council, a regional grouping that includes Riyadh, has already dismissed an embargo.

“The GCC works as a clear and honest partner as an oil exporter with the international community and we can’t use that as a weapon in any way possible,” said Jasem al-Budaiwi, the organisation’s secretary-general, at a press conference in October.

And bulk of oil from the region now goes to Asian nations such as China, India, Japan and South Korea rather than Israel’s principal backers in Europe and the US, a major difference compared to the situation when an embargo was imposed in 1973.

Giovanni Staunovo, a commodity analyst at UBS, noted that China recently brokered the normalization of relations between Iran and Saudi Arabia: “There’s limited interest to upset Asian demand,” Staunovo said of the major oil producers in the Middle East.

Closing the Strait of Hormuz?

A direct military strike by Israel on Iran could create an escalation spiral that would have a major impact on oil, potentially pushing the Islamic Republic to close the Strait of Hormuz, according to Papic.

But the probably of such a scenario is low, just 5 per cent, given the clear opposition from the US after President Joe Biden said publicly that Washington has no evidence Iran was behind the Hamas attacks, Papic wrote.

“This suggests that the US is not interested in a regional war between Israel and Iran,” he said “Given Israel’s massive technological superiority, it is the only country that actually has the ability to initiate such a conflict.”

And Iran would essentially be shooting itself in the foot by attempting to close the Strait, which it needs to keep open for its own oil exports, said Staunovo. Iran also doesn’t have the capability to pull such a move off, said Mike Rothman, president of Cornerstone Analytics.

“Their navy isn’t really capable of blocking the Straits and frankly it wouldn’t even be in there interest to do it because then it makes them a target of a lot of different countries,” Rothman said.

JPMorgan, in a research note published last week, noted that Iran has repeatedly threatened to block the Strait over the past decade in response to Western sanctions but did not make good on its threat, suggesting Tehran would prefer to avoid a full-blown war.

Blocking the Strait would harm both Iran and its primary oil customer, China, and would also impact the economic interests of the neighboring Gulf States. In essence, such a move would isolate Iran further.

“Unless Iran were able to convince the Gulf Cooperation Council that it was an act essential to self-defense, closure would be seen not only as a serious violation of international norms but, worse yet, one that directly impacts the economic interests of most Gulf states,” the JPMorgan analysts wrote.

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