What the Israel-Iran war means for oil prices

FOR THE past two years, the Middle East has been an even more tense place than usual. Houthis bombed commercial vessels; Israel began extensive military campaigns in Gaza and Lebanon; Iran and Israel exchanged rockets. Yet oil markets remained calm, since the worst-case scenario—a full-blown war between Israel and Iran—was avoided.

On June 13th, when Israel launched its first strikes on Iranian military and nuclear sites, that scenario became more vivid. Since then, the foes have traded drones and missiles. The list of targets has grown to include energy infrastructure on both sides. As we went to press, America’s president, Donald Trump, was weighing up whether to bomb Iran’s Fordow underground-enrichment plant; he and Ali Khamenei, Iran’s supreme leader, are already waging a war of words. A wider conflict could inflame the Gulf, which pumps a third of the world’s oil. Since Israel’s first strikes the price of Brent crude, the global benchmark, has risen by 10%, to $77 a barrel (see chart). How high might it go?

Oil markets are experiencing friction. Transponder jamming, first limited to waters around an Iranian port, is now complicating shipping across the Gulf. On June 16th it caused two tankers to collide off the Emirati coast. Both buyers and sellers of Iranian crude seem to have paused large shipments. Satellite imagery suggests the waters around Kharg Island, from where 90% of the country’s crude shipments typically depart, are eerily quiet, notes Antoine Halff of Kayrros, a data firm.

Yet, so far at least, the damage has not been too profound. Israel has attacked oil and gas facilities that serve Iran’s domestic needs, rather than export facilities, meaning little global supply has been lost. If that remains the case, prices should continue to hover around today’s levels. If the intensity of fighting were to ebb, they might even fall by $5-10 a barrel.

An Israeli strike on Iran’s oilfields or export facilities would send them in the opposite direction. Last month the Islamic Republic exported 1.8m barrels a day (b/d) of crude, equivalent to nearly 2% of global demand, according to Kpler, another data firm. A strike on Kharg could hinder lots of deliveries. Last year Iran began exporting crude from Jask, on the Gulf of Oman, in the hope of developing an alternative to Kharg, but volumes remain small and the terminal is also vulnerable to attacks.

In such a scenario, countervailing forces would play a role. Iran’s Gulf neighbours, who represent the core of the Organisation of the Petroleum Exporting Countries (OPEC), have lots of idle wells. Saudi Arabia and the United Arab Emirates alone have 3-4m b/d of spare capacity, which they could use in a crunch. It is not a given that they would do so quickly, since that might be seen by Iran as collaboration with Israel, inviting retaliation, and they would also not mind prices rising, having tried (and failed) to push them up over much of the past two years. But they might still impose a ceiling below $90 a barrel.

The more aggressively Israel behaves, and the more likely it is America steps in, the greater the chance that Iran resorts to desperate measures. Among the most desperate would be to try to close the Strait of Hormuz, through which more than a third of the world’s seaborne crude and a fifth of its liquid natural gas travel. Even in the “tanker war” of the 1980s, when Iran and Iraq fought and 239 oil tankers were bombed, shipments did not slow and prices stabilised after an initial spike. Iran would have to blockade the whole route. That would be rash, not least because the narrow waterway, which links the Persian Gulf to the Indian Ocean, is vital to Iran itself. Moreover, both America (whose president wants oil prices to stay low and who has a fleet stationed in Bahrain, across the Gulf from Iran) and China (which relies on oil imports from the Gulf) would probably send their navies in. There is a reason why, despite threatening such action several times, Iran has never taken the risk.

Pushed to the brink, however, it might. Analysts say the risk premium currently factored into the Brent price suggests that traders believe there is a 15-20% probability of such an intervention. If Iran were to go for the jugular, Saudi Arabia could divert some exports through its east-west pipeline, which has a capacity of 5m b/d, equivalent to about half the crude the kingdom produces. But 85% of Iraq’s exports, and all those of Bahrain, Kuwait and Qatar, have no other route to market, meaning Brent might then rush past $100 a barrel. Many other commodities normally shipped en masse through the strait, from fertilisers and food to minerals and petrochemicals, would also become more expensive.

And there is an even worse scenario. Many of the Gulf’s largest oil-production sites are within reach of Iranian missiles (see map). Protecting them all is just about impossible, especially in Saudi Arabia, where they are spread over enormous distances. Were Iran to bomb such sites, prices might exceed $120 a barrel. Would the fall of the Iranian leadership bring them back to earth? History suggests not. Since 1979, eight regime changes have occurred in big oil-producing nations. JPMorgan Chase, a bank, estimates that oil prices, on average, ended up stabilising at levels about 30% higher than before the unrest. In most cases, it took months for them to fall again. All this means that global oil markets have just become a lot more flammable. ■