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  • 24 Feb, 2024

Will the recent Middle East crisis affect the oil market?

Investors are on edge, but rising oil prices have so far shown no signs of panic buying.

It raises concerns that oil prices could be affected by last week's US and UK airstrikes in Yemen. Despite hysterical portrayals in the media, caution should be exercised before prematurely announcing significant increases in oil prices. Friday's 4% rise in crude oil futures is within the range of typical market moves. Taking a pragmatic approach to the situation is important, recognizing that trading algorithms readjust in response to Red Sea events.

It is important to counter market complacency. Historical examples, such as Abqaiq's attacks on Saudi Arabia's oil infrastructure in 2019, led to short-term spikes in crude oil prices. Markets now expect actual physical supply disruptions, barring an incident in the Red Sea. Markets experience supply losses in the Red Sea differently. Despite the recent increased response from the US and UK to this incident, we have seen only a small increase as the market has not yet experienced significant supply losses. Until a real disruption occurs, a sustainable and significant raw geopolitical risk premium is unlikely to emerge.

For now, oil markets seem to be ignoring the risk of oil supply disruptions due to the Hamas-Israel conflict. This is, perhaps unsurprisingly, wrong. This is particularly relevant given the possible consequences for Iran. Another factor to watch out for is Lebanon, where there is a high possibility that an Israel-Lebanon war could break out and shake up the crude oil environment. The current situation in the oil market is similar to the situation in the early 1980s and suggests macroeconomic inflation. Current expectations that Brent crude prices will rise to $82-83 per barrel in the coming weeks may be premature, given the Western economies' need for expensive oil. The early 1980s marked a turning point for the world oil market as the energy crisis of the 1970s subsided and a period of stability and falling prices followed. Amid supply uncertainty, strategic oil reserves have emerged as an important guarantee. The lessons of the early 1980s are similar to today's military attacks and rising geopolitical tensions. They emphasize the importance of strategic reserves and the need for an adapted global energy strategy to deal with current uncertainties and ensure a secure oil supply.

After the Great Depression of the 1970s, the oil market experienced a price increase between 1979 and 1980. However, in the early 1980s, this trend reversed dramatically, culminating in the infamous oil price crash of 1986. These trajectory changes reflect the complex dynamics of the oil market during the period, causing volatility. And in the end, it was rejected. The increase has driven change as consumers adopt alternatives, leading to a significant drop in overall oil consumption.

At the same time, increased production in non-OPEC countries, particularly in the United States, created a supply glut. As a result, OPEC, led by Saudi Arabia, prioritized market share over price support, causing oil prices to fall. The resulting economic disruption affected oil-dependent economies and contributed to the growth of oil-importing countries. Despite OPEC's efforts to stabilize prices through production quotas, internal dynamics have become more complex as members pursue different strategies. The sustainable lessons of the 1980s continue to influence global energy policy, with a focus on adapting and diversifying the emerging oil industry. The situation in the Red Sea requires careful analysis. This disruption is already seeping into the core of the EU.

Reuters reports, including that Tesla has closed its Model Y factory near Berlin due to supply chain adjustments due to tensions in the Red Sea, highlight the significant impact geopolitical events are having on the industry. About 30% of world trade passes through the Red Sea passage, so any disruption to this vital route would be problematic.

The latest figures show that the volume of trade has almost halved, forcing ships to make longer journeys. This is not just a nuisance at sea. This is a potential precursor to inflationary pressures. Long sea routes reduce the ability of ships to deliver goods quickly, a worrying scenario for countries like the EU and the UK, which rely heavily on imports. Despite these challenges, the impact on oil prices appears to have been limited to date. The level is much lower than it was a few months ago compared to the chaos that occurred in March 2021, when the container ship Ever Given blocked the Suez Canal for six days. The incident left hundreds of ships stranded at anchor and caused global trade losses of $9 billion for each day of downtime.

The difference lies in the resilience of today's supply chains compared to the networks that struggled in the past. The EU is concerned about the potential consequences of disruption to Red Sea trade routes, supply chain adjustments, and geopolitical risks. Investors, businesses, and governments closely monitor the situation and are aware of its impact on global trade dynamics. The market reaction was swift and increased oil price volatility led to speculative activity. Traders are positioning themselves strategically, as seen in the long call option spread on Brent crude oil. This adds unpredictability to an already dynamic oil market, impacting investors and consumers.

The economic significance goes beyond oil, given the Red Sea's role as a vital channel for global trade, accounting for 15% of world shipping. Increased volatility could disrupt the flow of goods between Europe and Asia, leading to supply chain disruptions affecting multiple industries and economies.

Red Sea tensions are a multi-faceted challenge that oil traders must monitor almost hourly. They expect further developments, but their outlook is prepared to adapt to new geopolitical risks.