- Commodity experts are now saying the oil markets have underpriced the risk of further escalation of the Israel-Hamas conflict.
- The price response to the escalation in the Middle East tensions has so far been modest.
- StanChart: Middle East geopolitical risk is currently being significantly under-priced and the current fundamentalsalone are enough to justify a complete reversal of this month’s price undershooting.
Last week, the Israeli government ordered its state-run electricity company to halt power supply to the Gaza Strip days after Palestinian militant group Hamas launched a surprise attack on the country. The Israeli prime minister’s office revealed that the security cabinet has approved several steps to destroy the military and governmental capabilities of Hamas and Islamic Jihad “for many years”, in a war that has seen more than 3,000 Palestinians and about half as many Israelis killed. But now there’s a growing risk this could escalate into a regional conflict after Lebanon-based Hezbollah warned that it’s ready to fully enter the war in support of Hamas. Indeed, there are growing fears that Hezbollah may open a new front against Israel at the behest of its leaders and their Iranian backers while Iran has warned of preemptive action against Israel if it goes ahead with a ground offensive. And some commodity experts are now saying the oil markets have underpriced this risk, and oil prices could skyrocket if the situation above unfolds. Commodity analysts at Standard Chartered have pointed to a medium-term reduction in Iranian oil exports as being the most likely consequence of shifts in the geopolitical landscape. Middle East tensions up till now have been modest; however, the Israel-Gaza war is likely to cause a significant shift in U.S. policy on Iran due to its open support and backing for Hamas. StanChart says that changes in positioning in the oil futures markets have been modest despite a significant increase in volatility. The analysts note that it is not an extreme tail of the distribution as might be expected in a full-blown Middle East crisis, adding that speculative positioning is also not extreme, particularly in Brent. The latest fund manager data shows that prices are about USD 6 per barrel (bbl) lower than in late September, Middle East geopolitical risk is currently being significantly under-priced and that current fundamentals alone are enough to justify a complete reversal of this month’s price undershooting. If anything, oil fundamentals have strengthened considerably. According to StanChart, global oil demand has already exceeded the pre-Covid oil demand set in August 2019, averaging 102.33 million barrels per day (mb/d), good for a m/m increase of 1.2 mb/d and a y/y increase of 2.3 mb/d. The analysts have refuted arguments by some Wall Street analysts that high oil prices have already triggered demand destruction. U.S. crude oil inventories at Cushing, Oklahoma, remained close to the operational minimum, falling 0.32 mb to a 15-month low of 21.77mb. US strategic stockpiles that were built just for a time like this have been depleted. The Biden administration squandered the reserves in a futile attempt to keep oil prices from climbing over $60 a barrel. This could get real ugly real fast.