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How Conflict in the Middle East Could Send Oil Prices Soaring

Ever since Hamas launched multiple coordinated attacks against Israel on 7 October last year, the Middle East has been on the verge of spiraling into an out-of-control regional and perhaps global conflict. Perhaps no time has looked potentially more perilous for the region and for those countries connected to it through politics, economics, or energy prices than right now. On 27 July, Iranian-backed Lebanese terrorist organization Hezbollah killed 12 children and young adults in a rocket strike on a playing field in the Israeli-occupied Golan Heights. 30 July saw an Israeli air strike kill Fuad Shukr, a senior Hezbollah military commander, and close adviser to the group’s leader, Hassan Nasrallah. On 31 July, Israeli forces assassinated the political head of Palestine’s Hamas terrorist organization, Ismail Haniyeh, who was in Iran to attend the inauguration of the new president, Masoud Pezeshkian. Hamas, Hezbollah, and Iran have all vowed revenge.
Israel’s conflict with Hamas is now well advanced, so the opportunity for a dramatic escalation in violence from the group appears less likely than from either Hezbollah or Iran. For Lebanon’s Hezbollah, it is a different matter entirely, with around 100,000 in its fighting force, a huge arsenal of weapons including up to 200,000 rockets and missiles, and all of this positioned directly to Israel’s north. It is also a key beneficiary of help from Iran in the training of its fighters and in the supply of short-, intermediate-, and long-range unguided ballistic missiles and short-range guided ballistic missiles capable of hitting all of Israel’s major population centers. Its history of warfare against Israel stands out among its Middle Eastern neighbors, having successfully driven Israeli forces out of Lebanon in 2000 and having fought them again in 2006, that time to a stalemate. A full mobilization of Hezbollah against Israel, at the same time as ongoing conflict on another front against Hamas could significantly stretch Israel’s defense capabilities – even more so if augmented by aerial attacks on Israel by Iran, or by additional forces from Syria to Israel’s northeast supported by the Iranian military and its proxies.
In Iran’s case, several other retaliatory options are available, in line with the comment from its Supreme Leader, Ali Khamenei after the Haniyeh assassination that Israel had set itself up for “harsh punishment”. From the energy sector’s perspective, Iran could threaten to further disrupt shipping through the Strait of Hormuz, through which around 30 percent of all the world’s oil has historically transited. Similar threats in the past have caused big spikes in the oil price. A less direct threat would be using its Yemeni Houthi proxy forces to step up the level of attacks on oil shipping elsewhere around the Red Sea region, which would also put upward pressure on oil prices. The Houthis could also be used to launch direct attacks on Saudi Arabia’s oil facilities, as the group threatened to do recently if Saudi Arabia continued to allow U.S. warplanes to use its territory for military strikes against the Yemeni rebel group. The last time the Houthis launched major coordinated attacks against the Saudi Arabian mainland - on 14 September 2019 against the Abqaiq oil processing facility and Khurais oil field - Saudi Arabia’s oil production was halved, causing the biggest intra-day jump in oil prices in U.S. dollar terms since 1988, as analyzed in full in my latest book on the new global oil market order.
Alternatively, Iran could widen out its previously called-for embargo by Islamic members of OPEC on oil exports to Israel’s allies as well as to Israel itself. This would mirror exactly what Saudi Arabia did in 1973/74 to countries that supported Israel during the Yom Kippur War with Egypt and Syria. As global oil supplies fell, the price increased dramatically, exacerbated by incremental cuts to oil production by OPEC members over the period. Gas prices also rose, as historically around 70 percent of them are comprised of the price of oil. By the end of the embargo in March 1974, the price of oil had risen around 267 percent, from about US$3 per barrel (pb) to nearly US$11 pb. This, in turn, stoked the fire of a global economic slowdown, especially felt in the net oil-importing countries of the West.
Precisely where such escalations might drive the oil price was sketched out by the World Bank shortly after the 7 October Hamas attacks. It stated that a ‘small disruption’ – with the global oil supply being reduced by 500,000 to 2 million bpd (roughly the same as the decrease seen during the Libyan civil war in 2011) – would see the oil price initially rise 3-13 percent. A ‘medium disruption’ – involving a 3 million to 5 million bpd loss of supply (roughly equivalent to the Iraq war in 2003) would drive the oil price up by 21-35 percent. And a ‘large disruption’ – featuring a supply fall of 6 million to 8 million bpd (similar to the drop seen in the 1973 Oil Crisis) – would push the oil price up 56-75 percent. On the current Brent oil benchmark price of around US$77 per barrel, this would mean a jump to about US$120-US$135 per barrel.
That said, any significant embargo on oil exports from the Islamic members of OPEC to Israel and its key supporters would likely result in a much bigger loss of global oil supplies - and consequently have a much greater effect on the oil price - than occurred during the 1973 Oil Crisis and that the World Bank has calculated. The Islamic members of OPEC are Algeria, with an average crude oil production rate of around 1 million bpd, Iran (3.4 million bpd), Iraq (4.1 million bpd), Kuwait (2.5 million bpd), Libya (1.2 million bpd), Saudi Arabia (9 million bpd), and the UAE (2.9 million bpd). This totals just over 24 million bpd - or about 29 percent - of the current average total global production of about 82 million bpd. Alongside such an embargo, Iran would certainly call upon its Houthi proxy forces to step up attacks on oil shipping in and around the Red Sea region to push oil prices even higher.
One key factor that may mitigate the risks of escalation spiraling out of control – as it has already done on several occasions since 7 October 2023 – is that neither of the principal superpower sponsors of the main opposing sides in this Middle East conflict wants oil prices to go much higher than they already are. As analyzed in full in my latest book on the new global oil market order, Israel’s key sponsor – the U.S. – has a longstanding interest in keeping the Brent oil price below US$75-80 per barrel. Prices over this significantly increase the chance of the economy slipping into recession. Historical precedent has been that every US$10 per barrel change in the crude oil price results in a 25-30 cent change in the price of a gallon of gasoline, and for every 1 cent that the average price per gallon of gasoline rises, more than US$1 billion per year in consumer spending is lost. And if the U.S. economy is in recession two years out from a major election (presidential or mid-terms) then the chances of the incumbent party in power winning are dramatically reduced. Since the end of World War I in 2018, the sitting U.S. president has won re-election only once out of seven such occasions (and even the one is debatable).
Iran’s key superpower sponsor, China, has the same desire as the U.S. for the oil price to be trading at the lower end of recent levels. Since 2017, it has been the world’s largest gross importer of crude oil, which is key to powering its still-stuttering economic recovery from its devastating Covid period. Consequently, although it enjoys substantial discounts on the headline oil prices offered to it by Russia, Iran, and Iraq, to name but three of its key suppliers, the lower the original price before the discount is applied the better for Beijing. At least as important as this to China is the fact that the economies of the West remain its key export bloc, with the U.S. still accounting for over 16 percent of its export revenues on its own. According to a senior European Union energy security source exclusively spoken to by OilPrice.com, the economic damage to China – directly through its own energy imports and indirectly through damage to the economies of its key export markets in the West – would dangerously increase if the Brent oil price remained over US$90-95 per barrel for more than one quarter of a year.
By Simon Watkins for Oilprice.com
Aug 6, 2024 09:26
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