Since mid-June, the oil market has been buffeted by sudden reversals in the Middle East.

At the time of writing, it appeared that the Iran-Israel conflict would be continuing with the possibility of the conflict intensifying. Shortly afterward, however, the U.S. entered the conflict directly by launching aerial attacks on Iranian nuclear sites, which led to a subsequent ceasefire.

While we were caught off guard by this dramatic halt to the conflict, the impact on the oil market aligned with our expectations, given that our expectations were for a negotiated settlement without major disruption to the flow of oil as the most likely outcome.

The basis for our expectations rested on several reasons. First, it has been our view that probability of Iran moving to close the Strait of Hormuz was very low since the closure would affect the movement of Iranian oil and that the probability would remain low unless Israel ramped up efforts to disrupt Iran’s oil production and exports.

Second, we thought Iran would be reluctant to take reckless military action with the threat of the U.S. becoming involved in the offensive part of the conflict.

Third, Iran’s main ally, Russia, did not step in with support, despite signing the Iran-Russia strategic partnership agreement in January.

Risk still looms

Despite the current cease-fire between Israel and Iran, the impact of geopolitics on the oil market is still looming. The recent renewal of attacks on shipping in the Red Sea by the Houthis after a months-long pause is one factor adding to the geopolitical risk. Additionally, the threat of Iranian nuclear capabilities has not been entirely eliminated, leaving the possibility that Iran will be able to still make use of uranium that was enriched before the U.S. attack on its nuclear facilities.

In mid-July, President Donald Trump announced an increased supply of military equipment and weaponry to Ukraine, along with enhanced sanctions against Russian sanctions. They include the 500% tariff on goods from Russia and countries importing Russian oil, including India.

Such a sanctions package is being pushed in the U.S. Senate and Trump has signaled support with the caveat that he wants to have the authority to control the imposition and removal of the sanctions.

If Trump does move forward with the secondary sanctions, it sets the stage for retaliatory responses from China, including restrictions on exports of rare earth elements, since it is highly improbable that China will adhere to unilateral sanctions imposed by the U.S.

While India can be expected to be more open to adhering to the sanctions, it is likely that India will plead for time to shift away from Russian oil. So, in the immediate aftermath of the imposition of the enhanced sanctions, the impact on Russian oil exports will be minimal.

OPEC’s stance

Looking further out, additional supply from OPEC+ could help mitigate the impact of lost supply, but the volumes will be insufficient to offset a significant loss of Russian oil exports. Effective sanctions on Russian crude oil would also put members of OPEC in an awkward position since the stability of the oil market requires cooperation between members of OPEC and Russia.

Consequently, it is possible that OPEC+ will pull back from the accelerated unwinding of previous supply cuts. Such a dynamic could provide an opening for U.S. shale oil producers to ramp up drilling activity and increase production, although it will take several months for the additional supply to be realized. As such, there will be increased risk with respect to supply for at least the next two quarters.

There will also be increased risk to demand with the additional economic friction being added by the threat of tariffs being considered by the Trump administration.

Besides the secondary tariffs associated with Russian oil, with the conclusion of the 90-day negotiating period, the Trump administration is once again threatening the imposition of elevated tariffs on trading partners. These threatened tariffs include a 30% tariff on imports from Canada and Mexico, 25% tariff on imports from Japan and South Korea, and 30% tariff on imports from the EU.

This combination of upside and downside risks will help moderate oil prices if there are limited unintended consequences. The potential for retaliatory actions and reactions, however, creates the dynamic for such unintended consequences and more extreme outcomes because of major shocks stemming from geopolitical and macroeconomic developments.