For more than a year, oil markets have given the cold shoulder to geopolitical risk. Despite the outbreak of a regional war in the Middle East, the world’s most important oil and gas exporting region, Brent crude prices at $74 per barrel are lower than they were before the conflict started. President-elect Donald Trump’s convincing win in the US has the potential to light a fire under the risk premium. After all, Trump is expected to target Iran with another “maximum pressure” campaign, repeating the sanctions that crushed Iranian exports from 2.8 million barrels per day to under 200,000 b/d in 2020. He has already assembled a who’s who of Iran hawks to join his team.
Today, Israel and Iran have not been this close to direct war in 70 years of regional conflict, with the two directly attacking each other for the first time in April.
An assertive US president, closely aligned with Israel and intent on hobbling Iranian oil exports, could escalate conflict in the heart of the oil-rich Mideast Gulf.
Even small missteps by a new administration, or a limited flare-up in tensions, could open up a new phase of the war, with oil terminals, refineries, pipelines and tankers potential targets for Iran or its allies, notably Yemen’s Houthis.
True, some suggest that Trump’s other policies could put downward pressure on oil prices — for example, his stated policies to stop wars, not start them, or his deployment of tariffs that could be a drag on global growth. This week, Elon Musk, who was appointed by Trump to head the newly formed Department of Government Efficiency, reportedly met with Iran’s ambassador to the UN. The meeting focused on how to defuse tensions between Iran and the US, according to The New York Times.
But Trump’s fixation on Iran only further increases geopolitical risk to markets, which has been on the minds of senior traders for months, Energy Intelligence understands.
And yet, prices have fallen instead.
Risk off
A decade ago, oil traders confronted with such headlines could easily have pushed prices up by double digits. History shows that Mideast wars often explode to create supply disruptions. The 1973 Yom Kippur war and Arab oil embargo led to higher prices over a sustained period, as did fallout from the Iranian revolution of 1979, the Iraqi invasion of Kuwait in 1990 and the Arab Spring in 2011.
Instead, Brent prices have recently fallen into the $70/bbl range, even dipping into the $60s in September.
So why is today’s oil market seemingly immune to a geopolitical risk premium?
There are many factors at play, including structural changes in production and trade.
The Atlantic Basin — fueled by the rise in US shale and, more recently, Latin American oil — has become a key exporter of crude and less dependent upon Mideast output.
There are also secular shifts in the global economy, with less reliance on immediate deliveries of oil, higher use of gas, more renewable energy and a rise in electric vehicles, particularly in China, which has been the engine of oil demand growth for the last 20 years.
At the same time, because of the potential for a major supply disruption caused by the Mideast conflict, risk capital and physical traders have flocked to the options market, which better hedges risk under extreme conditions. Activity in options markets, rather than futures, to cover upside risk blunts the impact of financial trading on the oil price.
Meanwhile, algorithm traders — involving automated trades that come in many shapes — provide liquidity in futures markets and drive some price volatility. These traders link oil to other assets, or thrive on momentum or scalp tiny arbitrage spreads, and can make up 40% or more of oil futures trading volumes these days.
In financial markets, traders have been fixated on disappointing numbers out of China in 2024, which have prompted most forecasters to revise down their demand projections. Opec now sees total demand growth at 1.8 million b/d in 2024, compared with earlier projections of 2.2 million b/d. Other forecasting agencies, including Energy Intelligence, have also cut demand expectations for this year based on the weak demand data coming out of China. Beijing deployed a $1.4 trillion stimulus package to counter its economic problems, but it will take time to see the impact.
Traders are well aware there is higher risk of disruption in the market but say they are more able to adjust these days and, like speculators, have options positions in place as insurance to mitigate physical supply risk. In the Russia-Ukraine conflict, flows were redirected, but no oil was shut in. Libya saw 50% of its production taken off line this summer, but traders said years of regular Libyan disruptions meant they were prepared to quickly source alternatives.
If there is a bigger or longer outage, market participants point to Opec’s 6 million b/d of spare capacity, which could offset most disruptions worldwide. This would be plenty to offset even an effective tightening of US sanctions on Iran’s 1.7 million b/d of exports.
Those safety nets are comforting until we look at the potential risk of a direct war between Iran and Israel. Such an outcome could result in the disruption or closure of the Strait of Hormuz, which Iran has threatened many times over the years. Almost all of Opec’s idle capacity sits inside the Gulf, and a closure could be catastrophic for oil markets, with prices potentially spiking to $150-$200/bbl, according to Energy Intelligence research earlier this year.
US Election Sentiment Shift?
The largest inflection point in sentiment may be the completion of the US election. President Joe Biden’s administration — knowing that a spike in gasoline prices could doom the Democratic presidential campaign — avoided any action that could spook oil prices ahead of the Nov. 5 vote.
Russia’s invasion of Ukraine in early 2022 set the tone for the policy of the Biden administration: It used releases from the US Strategic Petroleum Reserve to moderate prices and worked to ensure that sanctions did not directly threaten the flow of Russian oil, through the G7 price cap, for example.
In practice, this has meant that Biden officials often turned a blind eye to the sanctions-busting actions of Iran or applied looser restrictions to allow Venezuelan and Russian oil to flow. Energy Intelligence understands that the US also warned Israel against attacking Iranian oil infrastructure, which was initially mooted as a potential retaliation target following Iran’s firing of 180 ballistic missiles at Israel in early October.
Opec officials have intimated that the US influence over prices goes deeper than that, with some blaming stubbornly low prices on politics. As evidence, they raise questions about larger-than-usual revisions of official US data on demand, which the market trades on.
With the US election now in the rearview mirror and the Biden administration entering a lame-duck period before Trump takes office on Jan. 20, there is less political pressure to keep prices low. Once Trump takes over, he will get to work on his campaign promises. If getting tough on Iran and other producers turns out to be a top priority, markets may finally awaken to geopolitical risk.
Alex Schindelar is the president of Energy Intelligence, and Amena Bakr is a senior research analyst for the company, based in Dubai.