How the Israel-Iran Conflict is Shaping Oil Price Trends

As tensions escalate in the Middle East, the eyes of the investors are fixed on Israel’s response to Iran’s recent attack. On Monday, oil prices surprisingly dipped, despite the severity of the situation, defying expectations of a spike in response to the escalating conflict.

The cost of a barrel of Brent crude oil, the global benchmark, slipped to $89.64 on Monday, down 0.9% from Friday’s closing price. Similarly, West Texas Intermediate, the North American benchmark, saw a 0.9% decrease to $84.90 per barrel. This unexpected turn in the market came after Iran launched over 300 drones and missiles towards Israel from its territory over the weekend, marking a significant escalation in hostilities.

Why hasn’t the oil price surged following Iran’s attack on Israel?

Despite initial fear of a prolonged conflict, Brent crude prices only reached a six-month high of $92.18 per barrel on Friday. This modest increase followed warnings from Israel’s allies about an impending Iranian retaliation for an Israeli strike on an Iranian diplomatic building in Syria. However, Israel and its allies were able to intercept and neutralize most of the incoming missiles, thanks to advance warning. Due to this, analysts speculate that the attack may not usher in a full-blown war.

According to Bob Savage, head of markets strategy and insights at BNY Mellon, the moderate rise in oil prices and boost in investments in supposed safe havens like gold, suggest that investors are cautiously optimistic that the attack was an isolated incident.

What if Israel decides to escalate the situation?

Before Iran’s threat of attack came to light, previous conflicts between Israel and Hamas had little to no impact on the energy markets. An all-out war between Israel and Iran, however, would present an entirely different scenario. Iran, as a founding member of OPEC, produces approximately 3.2 million barrels of oil per day, making any disruption to its production capacity a significant concern for global oil markets.

Although Iranian oil is under sanctions, any kind of reduction in production could still cause oil prices to rise. As per the International Energy Agency, Iran, in 2023, was the world’s second-largest contributor to supply growth after the US. Analysts at Citigroup suggest that oil prices could cross $100 per barrel if direct conflict ensues.

Could the prices decrease if tensions ease?

Analysts headed by Daan Struyven from Goldman Sachs are of the opinion that current oil prices already include a risk premium due to concerns about potential supply disruptions. However, if tensions in the Middle East were to de-escalate, this price premium could slowly disappear, leading to a decline in oil prices over time.

Despite this possibility, analysts at Goldman warn of various other factors that could keep prices elevated. OPEC and its allies, including Russia, might choose to extend production cuts to maintain higher prices. Moreover, any escalation of conflict could result in significant damage to oil infrastructure or disrupt the flow of oil through key trade routes like the Strait of Hormuz, leading to further price hikes.

Broader implications of rising oil prices

Higher oil prices pose a challenge for central banks worldwide, especially since they navigate the delicate balance between combating inflation and supporting economic growth. On one hand, central banks like the US Federal Reserve, the European Central Bank, and the Bank of England consider interest rate cuts to stimulate growth, while the International Monetary Fund cautions against premature rate cuts due to long-lasting inflationary pressures.

In the event of a continued rise in oil prices, inflationary pressures might persist, forcing central banks to delay rate cuts. Extended periods of higher interest rates could, in turn, suppress economic growth, presenting a significant challenge in an election year.