Geopolitical Conflicts Drive Oil Price Surge: Risk of Supply Disruptions?
On October 7th, international oil prices closed more than 3% higher, with Brent crude futures breaking the $80 per barrel mark for the first time since August. Brent crude futures rose by 3.7%, settling at $80.93 per barrel; U.S. crude futures also increased by 3.7%, reporting $77.14 per barrel.
Prior to this, last week saw Brent crude and U.S. crude both accumulate a weekly gain of over 8%, marking the largest single-week increase since March 2023, with the October increase already surpassing 10%.
Li Jie, a senior researcher in energy and chemical industry at CCB Futures, told a reporter from 21st Century Economic Report that this round of international oil price increases was mainly driven by the geopolitical situation in the Middle East. The Middle East is a key hub for global crude oil supply, and geopolitical risks exert pressure on oil prices.
It is important to note that in recent years, Iran's crude oil production has been steadily rising, approaching 3.3 million barrels per day in August 2024, a 50% increase since Biden took office. Iran is the third-largest oil-producing country in the Organization of the Petroleum Exporting Countries (OPEC) and controls the Strait of Hormuz, through which more than 20 million barrels of crude oil were transported daily in 2023, accounting for over 20% of the global demand. Li Jie warned that if the situation in the Middle East continues to escalate and disrupts transportation routes, major oil-importing countries in Europe and Asia will have to seek alternative supply sources, increasing procurement costs and leading to a sustained rise in global oil prices.
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Although the market has already begun to anticipate oil prices reaching $100 per barrel, there are uncertainties about whether oil prices will soar next, with the direction of the Middle East situation being crucial. Will Israel strike Iranian oil facilities? What are the risks of the Strait of Hormuz being interrupted? Is OPEC willing to release idle production capacity? These questions still await answers.
Supply disruption risks emerge
Since Iran launched a large-scale missile attack on Israel on October 1st, Israel has vowed to retaliate, suggesting it may target Iranian oil facilities. On the 8th, local time, informed sources in the Iranian military revealed that the Iranian military has prepared "at least 10 plans" to counter potential military actions by Israel.
It is important to note that the market has been "immune" to geopolitical risk factors, believing there was no risk to crude oil supply. However, the recent sudden escalation of tensions in the Middle East has brought the risk of supply disruption to the forefront.Senior economist in the oil industry, Zhu Runmin, analyzed to the 21st Century Economic Report journalist, stating that at the beginning of October, Iran fired hundreds of ballistic missiles at targets within Israel. Israel declared that it would retaliate, although the retaliation has not yet been implemented. However, Israel has intensified its strikes against Hezbollah in Lebanon, and the geopolitical situation in the Middle East shows a further escalating trend, with Iranian oil facilities potentially becoming a significant target for Israeli retaliation. If Israel were to strike Iranian oil facilities, causing a large-scale shutdown of Iran's oil production, processing, and export facilities, millions or even tens of millions of barrels of oil supply could be impacted daily.
In extreme scenarios, Zhu Runmin analyzed that if a large-scale conflict were to break out between Israel and Iran, the Strait of Hormuz, a vital throat for international oil shipping, might close. If this were to happen, it would lead to the interruption of tens of millions of barrels of oil shipping daily, and many countries and regions around the world that rely on the Strait of Hormuz for oil imports would face severe supply issues. At that time, the international crude oil price would no longer be a matter of $80/barrel or $90/barrel; a new round of international crude oil price surges might be initiated prematurely.
The Strait of Hormuz is the world's most important energy channel, with over one-fifth of the global oil supply passing through this narrow maritime passage. The channel is used by Gulf countries such as Iran, Saudi Arabia, and the UAE and is a strategic shipping route connecting Middle Eastern crude oil producers with the world's major markets.
Alan Gelder, Vice President of Oil Markets at Wood Mackenzie, said that the market is currently pricing the possibility of Israel attacking Iranian oil facilities, but this is not the worst-case scenario. The worst-case scenario would be interference in the Strait of Hormuz, which would have a more drastic impact on crude oil prices.
The impact of the Middle East situation remains uncertain.
For international oil prices, the direction of the Middle East conflict in the future is crucial, and the impact remains to be seen.
If there is no substantial impact on Middle Eastern crude oil supply in the future, there is a risk of oil price correction. Zhu Runmin analyzed that if, in the end, Israel's retaliation against Iran is not as severe as the market imagines, and it does not cause significant damage to Iranian oil facilities, and both countries, like before, take action and then announce a temporary end to the counterattack, international crude oil prices may fall rapidly.
Han Zhengji, a crude oil analyst at JLC, told the 21st Century Economic Report journalist that in the short term, as market concerns ease, there is a risk of oil price correction. However, overall, geopolitical situations still mainly support oil prices. The Israel-Palestine conflict has been going on for a year, with not only no substantial progress in negotiations but also tense trends in Lebanon-Israel and Iran-Israel situations. It is difficult for the Middle East situation to stabilize in the short term. Even if crude oil supply is not impacted, as long as the Middle East situation is not actually stable, market concerns cannot be completely alleviated, which will support oil prices.If the supply of crude oil from the Middle East is disrupted, there is still room for international oil prices to continue rising. Goldman Sachs believes that if Iran's oil supply is affected, Brent crude prices could reach $90 per barrel or higher, with the specific price impact depending on whether other OPEC member countries increase production to compensate. If Iran's supply decreases by 1 million barrels per day, and OPEC takes action to fill the supply gap, Brent crude prices could rise to around $85 per barrel. In the absence of measures, Brent crude prices could peak at around $95 per barrel.
Zhu Runmin analyzes that the future oil prices largely depend on the restraint and conflict level between Israel and Iran. If it does not escalate into a local war and does not lead to the closure of the Strait of Hormuz, the impact will be relatively weak. Even if Iran's supply to the international oil market is interrupted, with an impact of only over 1 million barrels per day, the room for international crude oil prices to rise is limited, and they may climb to around $90 per barrel.
OPEC's spare production capacity is an important force in balancing the oil market. Claudio Galimberti, Chief Economist at Rystad Energy, said that as conflicts in the Middle East intensify, the risk of oil supply disruptions is increasing. However, OPEC has a large amount of spare production capacity that can fill potential supply gaps. "In the face of the most severe and widespread crisis in the Middle East in forty years, these spare capacities will prevent oil prices from getting out of control."
However, there is still uncertainty about whether OPEC's spare production capacity will be significantly brought online. Han Zhengji analyzes that for OPEC, its spare production capacity can indeed act as a buffer. However, countries like Saudi Arabia have a demand for high oil prices. If oil prices rise, it aligns with their interests, then OPEC's production policy may not undergo significant adjustments.
In the extreme case of the closure of the Strait of Hormuz, OPEC's spare production capacity may not be effective. Bob McNally, President of Rapidan Energy and former White House energy advisor, warns that once there is a serious disruption in the Persian Gulf, these oil supplies will be meaningless. "Spare production capacity will not help because most of this oil will be trapped within the Strait of Hormuz."
How will international oil prices evolve?
Boosted by geopolitical factors, international oil prices in the fourth quarter have changed from the previous downturn, but with a mix of bullish and bearish factors, there is still uncertainty about future oil prices.
Han Zhengji analyzes that generally speaking, the fourth quarter is usually the off-season for crude oil consumption. During this period, global oil demand will show a gradual shrinking trend, and crude oil prices will also decline step by step. However, this year's crude oil market may have a rebound opportunity.From the demand side, seasonal cooling of oil demand is expected to occur. However, from the supply side, in order to prevent further decline in oil prices, OPEC+ has postponed the resumption of additional production cuts to December, which limits the total supply of crude oil. Additionally, as the Federal Reserve enters a rate-cutting cycle, it will, on one hand, suppress the US dollar exchange rate, and on the other hand, reduce loan costs and promote economic development, thereby boosting crude oil demand and prices.
Middle East geopolitics and the US election are the main sources of uncertainty. If geopolitical tensions escalate, they will inevitably push up crude oil prices in the short term, and vice versa. The energy-related policies of the next US president will also affect the supply and demand pattern of crude oil in the coming years.
Overall, the future outlook for the oil market is cautiously optimistic. From the supply side, although market news previously suggested that Saudi Arabia might abandon production cuts to secure market share, Li Jie cautions that Saudi Arabia has a strong demand for oil prices, and the US currently lacks the ability to significantly increase production. OPEC+ can still support oil prices through proactive production cuts. In the current market environment, Saudi Arabia's main approach remains to sacrifice market share to ensure oil prices. If oil prices drop significantly again before the production increase in December, Saudi Arabia is highly likely to reduce production on its own or jointly with other member countries to control supply.
On the demand side, as the market approaches the transition between the off-peak and peak seasons, this year's peak season terminal demand was lower than market expectations. However, China has recently introduced a series of stimulus policies that support crude oil and other commodity prices in the short term. Both the balance sheets of the US Energy Information Administration and the International Energy Agency indicate that the market will continue to destock in the third quarter of this year, and the destock rate will narrow in the fourth quarter. Overall, the latest monthly reports from the three major institutions do not significantly downgrade the demand side, and the market will continue to destock in the fourth quarter. Coupled with the recent escalation of Middle East geopolitical tensions, Li Jie expects that short-term oil prices will continue to fluctuate at high levels.
In the long term, there is not much time left for the current global oil supply to be abundant. The conflict between Israel and Iran may prematurely end the era of abundant global oil supply. The new round of international crude oil price peaks will not be $100 per barrel, nor $120 per barrel; it is necessary to consider what to do when international crude oil prices reach $150 per barrel.
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