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Israel may not be an oil producing country, but the outbreak of war in the Middle East, which is the world’s top oil-producing region means more turbulence for energy markets.
If Iran were to become actively involved in the Israel conflict, pressure would come on the US and others to step up enforcement of sanctions on Iranian oil. This would create major global risks by disrupting energy supplies and pushing up oil prices.
The involvement of Iran and the strategic significance of the Strait of Hormuz, by which almost 20% of the world’s oil supply flows through daily, has the potential to make this conflict a global concern.
The situation remains incredibly fluid, and its ultimate impact will depend on how the conflict plays out. Oil price volatility is likely to be high in the near-term given the many uncertainties, and the conflict also comes at a time when global energy markets are already tense from supply cuts.
The rise in oil prices flies in the face of efforts to tame inflation by the Fed. There is a possibility that we might see inflation spike higher in future, and we expect that inflation would stay higher for longer going forward.
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The Israel-Hamas war
The Israel-Hamas war, which erupted on 7 October 2023, has sent shockwaves across the world.
Oil prices have been pushed higher since the outbreak with investors worried about the potential consequences. To gauge the impact, we will examine two primary scenarios: (1) The conflict remains contained and (2) Escalates to a broader regional conflict, to uncover what it means for oil markets.
Figure 1: Oil prices have been
pushed higher since the outbreak of the Israel-Hamas war
1) The conflict remains contained
The first case scenario, which is also the best-case scenario for the global economy – is that the war is contained to an Israeli ground assault on Gaza Strip. Given that neither side are key oil players, the conflict does not meaningfully impact oil production or supply. Israel for instance, has almost no domestic crude production, and imports around 220,000 barrels per day (bpd) of crude. Moreover, it has only two oil refineries with a capacity of just under 300,000 bpd.
2) Escalates to a broader regional conflict
The biggest risk at present is a localised conflict in Gaza turning into something far more serious. The second scenario involves a broader regional conflict, starting with fighting on Israel’s northern border with Iranian-backed Hezbollah forces in Lebanon, but eventually dragging Iran into the conflict.
Iran’s foreign minister has already called for a full and immediate boycott of Israel by Muslim countries, including an oil embargo on the country. These comments have marked a verbal escalation over the war between Israel and Hamas.
Moreover, if Iran were to become more actively involved in the Israel conflict, pressure would come on the US and others to step up enforcement of sanctions on Iranian oil, and this would lead to a reduction in supplies. US President Joe Biden has already condemned Hamas’ terrorist attack on Israel and conducted an impromptu one-day visit Israel on 19 October 2023 in a show of support.
Such actions would impact oil markets, as Iran has become a growing source of extra crude this year, alleviating an otherwise tightening market (Figure 2). The country is also the top five Middle East crude exporters (Table 1) and the world’s eighth-largest oil producer, producing about 3% of the global supply — well below the US and Saudi Arabia but just ahead of Brazil and Kuwait in 2022.
Figure 2: Despite existing US sanctions, Iran’s oil output has increased in recent times
Table 1: Top Middle East crude exporters in September 2023
|
Country |
Million barrels per day
|
|
Saudi Arabia |
6.11 |
|
Iraq |
3.22 |
|
United Arab Emirates |
3.21 |
|
Kuwait |
1.45 |
|
Iran |
1.42 |
|
Oman |
0.86 |
|
Qatar |
0.70 |
|
Egypt |
0.02 |
|
Source: S&P Global Commodity Insights Data as of 30 Sep 2023 |
|
Looking back at history, oil prices have risen from previous US-Iran tensions. Back in 2018, former US president Donald Trump withdrew from the nuclear deal between Iran and world powers and revived a range of sanctions against Iran and any countries doing business with the Islamic Republic. The news on 8 May 2018 caused Brent Crude to gain almost 3% a barrel a day to USD 76.95 and had also caused Brent Crude to gain about 16% since the start of 2018 as tensions had brewed up to this point.
US sanctions however, are not the worst case scenario. The worst case scenario would see the flow of crude to global markets being interrupted, probably by the closure of the Strait of Hormuz. Iran has previously threatened to close the strait to maritime traffic in 2018 as a retaliation to US sanctions.
The Strait of Hormuz, which is a thin strip of water by Iranian shores, is a key maritime transit route through which Persian Gulf exporters (Saudi Arabia, Iran, Iraq, Kuwait, Qatar, the UAE, and Bahrain) ship their oil (Figure 3). It is the world’s most significant oil chokepoint, by which almost 20% of the world’s oil supply flows through daily. Hence, the potential of the Israel-Hamas conflict to radiate beyond their shores and disrupt the global oil markets is not a risk to be taken lightly.
Figure 3: The Strait of Hormuz is
vital to the world’s oil supply flows 
Closing thoughts
Unlike the spike in oil prices that followed Russia’s invasion of Ukraine last year, the fighting between Israel and Gaza does not directly involve oil-producing nations. Hence, the immediate effect on energy prices is likely to be limited.
Nevertheless, the situation is incredibly fluid, and we are very much mindful that the impact will depend on how the conflict plays out. In the event of a further escalation, it could jeopardise crude exports from a region that accounts for about a third of global supply, thereby having the potential to pose as one of the most significant geopolitical risks to oil markets since the Russia-Ukraine war.
Oil price volatility is likely to be high in the near term given many uncertainties about the implications of the fighting for the oil market. Not to mention, the conflict also comes at a time when global energy markets are already tense, with both Saudi Arabia and Russia having announced voluntary supply cuts until the end of 2023. This in turn pushed oil prices to their year-to-date highs in late September. It is unlikely that OPEC+ would step up production amidst the ongoing regional tensions, as tighter supplies in face of rising demand allows producers to rake in extra oil revenue despite pumping fewer barrels.
Moreover, the rise in oil prices amidst such geopolitical conflicts has inspired fresh fears, as it flies in the face of efforts to tame inflation. Climbing oil prices increases energy costs for consumers and businesses, weighing on the global economy. There is a possibility that we might see inflation spike higher in future, as soon as the high-base effects of energy prices witnessed in 2022 starts to wear-off.
Figure 4: US CPI
components
Over the longer-term, constraints on production from the private sector coming from years of under-investment would likely mean that oil prices will likely remain higher for longer, as corporates prefer to focus on capital discipline instead. This forms a strong fundamental backdrop for oil prices, and in view of this, we expect inflation to remain higher for longer (above the Fed’s 2% target).
With oil prices likely to remain elevated, investors may wish to consider the Blackrock World Energy Fund. It has exposure to integrated players with an emphasis on production, which are well-poised to benefit from higher for longer oil price environment. Alternatively, investors can also consider the Blackrock Natural Resources Growth & Income Fund to get a diversified exposure to the commodities sector. The fund invests in natural resource companies, such as those involved in oil and gas exploration and production, as well as in metals and mining.
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