The massive spike in oil prices over the last couple of days are likely to be temporary, provided the current Middle East crisis is contained, experts say.
Oil prices climbed more than three per cent on Wednesday as Israel and the United States vowed retribution over Iran’s biggest ever direct attack on its regional adversary, Reuters reported. So far, oil prices rose by more than 4 per cent as escalation has intensified between Israel and Iran.
Amid this geopolitical scene, the risk of a jump in oil prices that could trigger another global inflation shock appeared to be materialising.
However, experts said investors had remained relatively sanguine against a backdrop of escalating tensions in the Middle East, with oil prices having fallen more than 10 per cent in the past three months and the US stock market remaining close to an all-time high.
Western financial capitals could be troubled by an uptick in oil prices, especially ahead of next month’s US presidential election. Inflation has cooled across advanced economies in recent months, paving the way for interest rate cuts by policymakers at the world’s top central banks.
Yet experts believe financial markets could still avoid panic, citing three key reasons: expectations for the future path of the Middle East conflict, geopolitics, and the increasingly shaky health of the world economy.
“It’s quite surprising when you see escalations and nothing moves, it’s not generally what you expect from markets. But it’s been escalating over the past 12 months,” Mohamed Hashad, Chief Market Strategist, Noor Capital, said in a note.
Analysts remain hopeful that the recent escalation can be dialled back. The stakes are high, however. Iran is a major oil producer, supplying about three million barrels a day – or about three per cent of world output – despite Western sanctions.
Tehran has significant influence over the Strait of Hormuz, a key chokepoint for oil and gas tanker shipments handling as many as 20 million barrels a day, almost 30 per cent of the world oil trade.
Iran also exerts control over the Red Sea through its backing of Houthi rebels in Yemen, who have been targeting shipping. Earlier this year, this was among the biggest fears in global financial markets.
This is where geopolitics come in. “Other major oil and gas exporters – including Saudi Arabia, Iraq, the UAE, Kuwait and Qatar – rely heavily on Hormuz, raising the prospect that Iran closing the chokepoint could have wider consequences,” Hashad said.
Economists say such a step could drive oil close to $100 a barrel. “However, given the likelihood of a military response – probably led by the US – economists doubt that Iran would, in practice, be able to close the strait for long,” Hashad pointed out.
After the 2022 Russian energy crisis, many countries moved to diversify energy supplies, including from renewables. Members of Opec+, a wider group of oil-producing nations including Russia, meeting on Wednesday are also expected to stick to plans to raise supply volumes.
“Supplies would not be impacted despite the situation around the Red Sea, Yemen, but by and large it’s more like a nuisance, but not really disruptive in any way,” Hashad said.
The third factor that could avert a financial market panic is the economy itself.
Oil demand has sagged amid a slowdown in global growth – particularly in China, the world’s largest consumer, where Beijing is battling to revive flagging activity. European industry is also in the doldrums, with surveys on Tuesday showing factory output fell in September at the sharpest rate this year.
Demand in China had dipped to a few hundred thousand barrels a day from about 1.3 million a day in 2023. Analysts believe these considerations point to a Brent crude price stuck in the $70s for the foreseeable future, with a geopolitical event or a recovering China the possible drivers of any upside surprise.
“Two years ago, the Russian energy shock came on top of an inflationary burst triggered by the easing of Covid restrictions and involving supply bottlenecks and red-hot demand from consumers eager to spend after lockdown. This time, inflation is cooling and consumer demand is weaker, reflecting the toll on household finances from the recent period of fast-rising prices, and higher borrowing costs used in response to the shock,” Hashad said.
Oil prices have fallen back from over $90 a barrel in April to about $70 – reflected in pump prices for motorists – helping further to ease inflationary pressures, at a time when the big focus in markets is on central banks cutting interest rates to avoid derailing economic growth.
However, further escalation in the Middle East could change all this. “Markets are yet to see it, but escalating conflict would have a further dramatic impact,” Hashad said.