Macro Intelligence: oil prices react to Middle East conflict - what's ahead for investors?

Article written by Juliette Saly

Middle East conflict

Commodity markets have surged following military clashes between Israel and Hamas in the Middle East.

Fears of escalating tensions sparking supply shortages led both the global benchmark crude Brent contract and the US WTI contract to surge by more than 4% each after the weekend attacks. This represented the largest one-day gain for both contracts in six months.

Meanwhile, safe-haven gold prices also experienced a spike, alongside agricultural commodities such as sugar and wheat. The primary fallout from geopolitical conflicts often manifests as a surge in oil prices due to supply and demand concerns. In February 2022, the oil markets witnessed significant increases as Russia invaded Ukraine.

The OPEC+ equation: how supply cuts and seasonal demand shape oil prices

The surge in oil prices at the beginning of the week countered a previous downtrend. Crude oil prices plunged approximately 8% per barrel in just two trading sessions, marking the steepest decline for both benchmarks since May.

This downturn emerged amidst concerns that demand is waning as the US summer driving season concludes, notwithstanding the OPEC+ agreement to sustain output cuts.

In the short term, fluctuations in global oil prices are to be expected as hostilities persist. Such volatility is likely to be passed on to consumers at the petrol pump.

AMP's Dr Shane Oliver predicts an increase in petrol prices due to the conflict, noting that recent market instability has negated any previous decreases in petrol costs. He forecasts that the risk now leans towards a potential 15-cent per litre increase in fuel expenses.

The Iran dilemma: geopolitical tensions and their impact on your fuel bills

Iran remains a pivotal focus for impending market volatility. Fears are growing that supply could be disrupted if Iran becomes further embroiled in the conflict.

A spokesperson from the White House has deemed Iran complicit in the Hamas attacks, although clarifying that the US has no intelligence or evidence suggesting direct involvement. Tehran, for its part, has refuted these claims but has expressed support for the decisions made by Hamas militants in Gaza.

Financial analysts speculate that ongoing turmoil could prompt the US to intensify its sanctions on Iran, consequently affecting Iranian oil exports. Additionally, the hostilities could hinder US diplomatic efforts to foster a rapprochement between Saudi Arabia and Israel.

Such an agreement had been anticipated to involve Saudi Arabia increasing oil output next year and normalising relations with Israel in exchange for a defence pact with Washington.

What is the lasting impact?

Some analysts argue that this week's price movement in oil markets is merely a "knee-jerk" reaction and likely to be short-lived.

Vandana Hari, from Vandana Insights in Singapore, suggests it's a "wait-and-watch situation," characteristic of any flare-up in the Middle East.

Vivek Dhar, CBA's Director of Mining and Energy Commodities Research, noted that "for this conflict to have a lasting and meaningful impact on oil markets, there must be a sustained reduction in oil supply or transport. Otherwise, and as history has shown, the positive oil price reaction tends to be temporary and easily trumped by other market forces."

Analysts further observe that the conflict does not directly jeopardize any significant sources of oil supplies, given that neither party involved is a major player in the oil market.

Israel's refineries and Tamar gas field

Data from the US Energy Information Administration indicates that Israel houses two refineries with a combined capacity of nearly 300,000 barrels per day.

Israel has also directed Chevron to cease operations at its Tamar gas field due to safety concerns. Situated off Israel's southern coast, this field is a significant contributor to the country's power generation and also supplies gas to Egypt. Concurrently, EIA data reveals that the Palestinian territories do not produce any oil.

OPEC's 2023 World Oil Outlook

Other factors influencing commodity markets are likely to continue shaping the direction of prices. Despite growing calls for climate action, the Organisation of the Petroleum Exporting Countries (OPEC) does not believe peak oil demand has been reached.

In its 2023 World Oil Outlook report, OPEC has revised its medium- and long-term global oil demand projections upward. The organisation estimates that by 2045, the world will require 116 million barrels of oil per day, approximately 6 million barrels per day more than it predicted in 2022, with an anticipated total investment cost of $14 trillion. In the previous year, global consumption was just under 100 million barrels per day.

OPEC attributes this expected surge in demand to economic growth in Asia, specifically China and India, as well as Africa and the Middle East.