N Chandra Mohan
Despite the raging war between Hamas forces and Israel’s army since October 7, a noteworthy feature is that global oil prices have so far not flared up. Although in the initial weeks, Brent crude spot prices remained elevated at $90 plus a barrel, they settled down to lower levels of around $79 a barrel in the last week of December 2023.
The threat, however, still remains. Overall, in December, prices at $77-78 a barrel were in fact lower by 17% when compared to $93.7 a barrel in September.
The downtrend in oil prices perhaps reflected an assumption that the conflict will not engulf the West Asian region that accounts for a major proportion of the world’s oil production. While those risks still remain heightened, a more fundamental factor is that the world is awash in oil due to rising supplies from the US—which accounted for four-fifths of the increase in 2023—Guyana and Brazil at a time of weakening global growth. There is record production in the US amidst a wave of consolidation by Big Oil.
All of this has more than offset the significant cuts in production announced by OPEC, although allies like Russia are exporting more in recent weeks despite pledges to reduce shipments.
The decline in oil prices despite the ongoing war between Hamas forces and Israel contrasts with earlier episodes when they have zoomed due to the so-called “fear premium” or jitters over disruptions in oil supplies. Not so long ago, there was turmoil in West Asia, with drone strikes on September 14, 2019 targeting oil processing facilities at Abqaiq and Khurais in eastern Saudi Arabia, cutting the kingdom’s oil production by about half—representing about 5% of global oil production—and causing some destabilisation of global oil markets. The attacks on January 17, 2022, on fuel tankers in the United Arab Emirates resulted in oil prices spiking upwards to a seven-year high.
These jitters are similarly bound to reflect in higher prices as risks rapidly escalate of the current conflict spilling over from Israel to Lebanon and Syria ultimately involving Iran for supporting Hamas and other militias like Hezbollah in Lebanon and the Houthis in Yemen. Currently, there is intense shelling from Israel into southern Lebanon. US forces have retaliated to attacks by Iranian-backed militias in Iraq and Syria. US helicopters shot 10 Houthis for targeting vessels. Iran has sent a warship to the Red Sea. Israel’s defence minister, Yoav Gallant, has ominously warned of the prospect of a “multi-arena war” notably, in Gaza, occupied West Bank, Lebanon, Syria, Yemen, Iraq and Iran.
The prospects for seven theatres of war getting active with missile and drone attacks near where oil is produced naturally will roil oil markets. How much prices will zoom obviously depends on their impact on disruption to oil supplies.
According to the World Bank, in a small disruption scenario of global oil supplies reducing by 0.5-2%, comparable to the Libyan civil war in 2011, prices will go up to $93 to $102 a barrel. In a medium risk scenario, the disruption in global oil supplies rises to 3%, as during the Iraq war in 2003, raising prices to $109-121 a barrel. In the large disruption scenario, global oil supplies are down by 6-8% , like during the Arab oil embargo of 1973, resulting in a price spike to $140-157 a barrel, which can trigger global stagflation.
The outlook on global oil prices could be much worse if the Hamas-Israel conflict involves Iran. As yet, there is no evidence of its direct involvement behind Hamas’s attacks in Israel, but the probability of further US-led sanctions cannot be ruled out, including curbs on its sale of oil.
Iran is the third-largest OPEC producer, generating 2.97 million barrels per day in July-September 2023. These sanctions would straightaway take out 2.9% of global crude supplies. It is true that past sanctions during November 2011 to October 2012 and ongoing ones since July 2018 led to only small declines in global oil supplies by 0.9% and 1.2%, respectively, resulting in limited price spikes.
But the current situation portends a more dismal scenario if Iran chooses to retaliate by blockading the Strait of Hormuz which is located between Oman and Iran and connects the Persian Gulf with the Gulf of Oman and the Arabian Sea. Flows through the Strait in 2022 and the first half of 2023 made up more than one-quarter of total global seaborne traded oil. In addition, around one-fifth of global liquefied natural gas trade also transited the Strait in 2022 according to the US Energy Information Administration.
Oil prices then would spike much more than the risk scenarios outlined earlier and bring the world economy to its knees. International diplomacy must therefore prevail to end the conflict before it spreads to the region and reverses the current softening of oil prices.
(The writer is an economics and business commentator based in New Delhi. Views are personal.)