By K Raveendran
A sudden spike in the oil price in the wake of Israel’s retaliatory missile attack on Iran seemed to have upset the calculations of a relative stability in the crude oil market, but the unexpected development, both in terms of the retaliation and its market impact, appears to have been contained without much damage.
After reaching a peak over the weekend following the Israeli missile attack, crude prices declined across the spectrum. Oil prices initially reacted rapidly in the wake of the attack, jumping from $86.7 per barrel of Brent crude to $90.6 per barrel. Prices have since dropped close to $87 per barrel per barrel.
Obviously, the oil market is glued to the situation in which international pressure, surprisingly, led by the United States, has curbed Israeli recklessness aimed at expanding the scope of the war, giving a certain reassurance to the markets about the safety of global energy supplies.
This has to be also viewed in the context of the global economic scene, which does not favour much oil market gains, with sentiment deteriorating around the possibility of an interest rate cut in the second half. It seems that the new reality has found its way to the markets through the accumulation of inventories to the extent of more than expected.
While it is difficult to assess whether this a temporary blip or the start of a new escalation in conflict between Iran and Israel, the initial market reaction suggests the former is more likely. For instance, Rystad Energy continues to believe that the non-escalation scenario is the most likely.
The reading does not, of course, envisages an end to the hostilities and armed attacks. There may still be calibrated attacks between parties, as appears to have been the case with Israel’s latest attack. The risk, however, is that a miscalculation from any of the parties could rapidly trigger a new escalation in an already volatile region.
If there is one certainty, it is that geopolitics will play an even bigger role in the oil market in the coming days and weeks. As such, the market can expect significant volatility in the near future, as it happened with the Friday attack.
Rystad Energy calculates that ‘fair value’ of Brent for the month of April, based purely on supply and demand fundamentals, is slightly below $83 per barrel. This means the current geopolitical risk premium is around $5 to 6 per barrel.
It is believed that, barring a significant escalation in conflict in the Middle East, the geopolitical risk premium will stabilize and gradually decrease. There are two reasons for this assertion. First, OPEC+ holds an unprecedented large volumes of spare capacity, at close to 7 million barrels per day, while the second one is that after a few weeks, in the absence of actual supply disruptions, geopolitical fatigue starts to play a role.
Eyes in the oil market and beyond are trained on the Middle East, to see if Israel’s missile attack is a one-time event or the spark igniting a wider conflict between the two regional powers. Israel launched a missile attack on Iran early on 19 April in retaliation for an Iranian attack on Israel six days earlier. Explosions were heard in Iran’s central city of Isfahan, where a large army base is located, as reported by the media. Iranian officials are downplaying the attack’s severity and denying any damage on the ground.
Importantly, reports have said that Iranian officials state there are no plans for an immediate retaliation against Israel.
It all depends on whether prime minister Netanyahu is exposed to more pressure, whether from the Gaza front, from the far-right coalition, or even from street pressure. This may push him to reignite the fuse of the regional war – as he did in targeting the Iranian consulate – to maintain his position. The market is well aware of this uncertainty as sudden developments could change the scene within moments.
The latest episode highlights the significant influence geopolitics wields over oil prices. Analysts estimate that the current price of Brent crude incorporates a “geopolitical risk premium” of around $5-6 per barrel, on top of the baseline dictated by supply and demand fundamentals. This premium reflects the heightened uncertainty and potential for disruption arising from the Israeli-Iranian conflict.
Experts believe this premium will likely stabilize and eventually decline, barring a major escalation. Two key factors underpin the expert view of risk premiums. First, the OPEC+ producer cartel holds a substantial reserve capacity – close to 7 million barrels per day – which can be utilized to offset any Iranian supply disruptions. Second, ‘geopolitical fatigue’ sets in after a period of heightened tensions, leading markets to adjust and price in the new reality, even if hostilities continue at a simmering level.
At the same time, it is not to be missed that the risk of miscalculation remains high. While a full-blown war seems unlikely, further ‘calibrated attacks’ as analysts describe the recent Israeli strike, could reignite market jitters and send prices soaring again. The ever-present possibility of unforeseen events adds another layer of volatility. (IPA Service)
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