How High Could War In The Middle East Drive Oil Prices?

• A repeat of the 1973 oil crisis is unlikely at this moment in time. 
• Analysts appear to have a consensus of sorts that the biggest problem for oil supply security would be the direct involvement of Iran in the Israel-Hamas war.
• A possible Israeli strike on Iranian oil assets could significantly drive up crude prices.

When Hamas struck Israel earlier this month, the first reaction of many people watching the energy space was the recall of a memory: a memory of the 1973 oil crisis.

In that year, another Arab-Israeli war resulted in an Arab oil embargo on the biggest Western importers of Middle Eastern oil, which in turn led to massive oil shortages, lines at gas stations, and a surge in inflation.

Yet, as knowledgeable observers note, the oil supply situation now is very different from what it was in 1973. Today, there are more non-OPEC producers than there were back then, led by none other than the United States, which suffered perhaps the worst blow from the 1973 embargo.

Things in 2023 are very different today than they were in 1973. Yet, a disruption in the supply of the world’s core commodity is still possible. The fallout, however, would likely be smaller than the effect of the 1973 embargo.

The U.S. today is not just an oil producer. It is the world’s biggest producer. Unfortunately, it also remains one of the biggest importers of the commodity, at a rate that has hovered around 6 million barrels daily for the past few years.

Meanwhile, India and China have become the biggest demand drivers with their high rates of import, with China leading the world with a record 11.4 million bpd in oil imports during the first half of the year.

This has been enough to start analysts talking about a return of Brent to $100 per barrel, and many have done just that. Natural gas prices, meanwhile, are such a concern for import-dependent Europe that the EU is currently considering an extension of a gas price it approved this February in an attempt to bring prices down.

The measure was controversial among members, and it was certainly not welcomed by gas exporters, but as the shock waves of the Russia-Ukraine war died down, gas prices went the same way, eliminating a scenario where the EU has to see gas exporters’ reaction to its price cap.

This is another marked difference with 1973, by the way. This time, it is not just oil supply security that is a cause for concern, it is gas supply security as well, after Israel became a major gas producer in the Eastern Mediterranean thanks to two massive offshore finds. Now, one of these has been shut down for safety reasons. Gas prices jumped immediately, and now the EU is talking about a gas price cap extension.

It is oil supply that is the biggest concern, however, and with good reason. Already, analysts appear to have a consensus of sorts that the biggest problem for oil supply security would be a direct involvement of Iran in the war. That would automatically lead to a U.S. response in the form of sanctions, and those will also automatically target Iran’s oil industry. Related: No More Oil Hedging For Hess After $53B Chevron Acquisition

There is also the possibility of an Israeli strike against Iran that could damage its oil infrastructure and the no less disruptive possibility of Iran shutting the Strait of Hormuz—potentially in response to such a move by Israel—where a solid chunk of global oil flows pass.

Luckily for our oil-dependent economies, such a course of events is, as of now, quite unlikely. It is not the war itself that is the biggest threat to global oil supply security. The biggest threat is what the war will do on an already tight market, and this we are already witnessing.

First and most significantly, the war exposed the breakdown in U.S.-Saudi relations. The Kingdom was in the process of restoring diplomatic relations with Israel—with U.S. moderation—but after the recent missile strike on a Gaza hospital, Riyadh immediately condemned the Israeli army and stated its support for Palestine.

This effectively put an end to the normalization talks, demonstrating that its interests—as Sanford Bernstein analyst Neil Beveridge told the Wall Street Journal—no longer align with U.S. interests. It also meant that Saudi Arabia feels no compunction to keep the global market well supplied because the biggest oil consumer on this market is its ally, the U.S. And this, in turn, meant that the Saudis could extend their production caps for as long as they want to keep prices higher.

The second important outtake from the latest events in the Middle East is that despite the massive effort to reduce at least some regions’ dependence on oil by investing trillions in alternative ways of generating energy, the world remains entirely dependent on it, including transition-ambitious Europe and even more transition-ambitious China.

That little fact there is evidence that the more things change, the more they stay the same. Back in 1973, the U.S. had an oil industry in decline, China was an insignificant consumer of oil, and OPEC ruled the world’s oil supply.

Now, the U.S. is the world’s biggest producer of oil, China the biggest importer, and Europe is trying to wean itself off the thing. But OPEC, apparently, still rules the world’s oil supply. And just because oil prices fell over the weekend thanks to reports that diplomatic efforts to contain the conflict continued, it does not mean the danger of oil rising to $100 and possibly higher is over. The only thing preventing that, in fact, is Saudi Arabia’s and its OPEC+ friends’ unwillingness to overdo the market control and cause demand death.

By Irina Slav for Oilprice.com

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