Why are oil prices falling as the war in the Middle East continues?

Intense fighting is taking place in a region that holds much of the world’s oil resources. However, after a few days of anxiety following the bloody October 7 raids by Hamas militants in Israel, energy markets have plummeted. Brent crude, the international oil benchmark, is selling for about $80 a barrel, cheaper than when the fighting began.

Why aren’t prices higher? A main reason, analysts say, is that the fighting, however vicious, has produced little disruption to oil supplies, leading traders to conclude there is no immediate threat.

“While traders realize there is increased risk, that hasn’t led to much pre-emptive buying,” said Richard Bronze, head of geopolitics at Energy Aspects, a London-based market research firm.

Regarding the Middle East, markets are “effectively ruling out that anything could go wrong,” said Raad Alkadiri, managing director of energy and climate at Eurasia Group, a political risk firm.

Alkadiri said traders are unlikely to raise prices unless they see “real barrels removed” from the market.

The market appears to have locked down the war and returned to a mood of pessimism about future oil demand, dominated by economic concerns about China, the largest oil importer, and other large consumers. Saudi Arabia and other producers have been trying to support prices by reducing their oil production.

Forecasters warn that 2024 could be a difficult year for oil markets. The U.S. Energy Information Administration predicted this week that U.S. gasoline consumption would decline next year due to more efficient vehicle engines, a growing number of electric cars and fewer commutes as more people work longer hours. hybrids.

Bearish sentiment drove prices down sharply ahead of the conflict between Israel and Hamas and appears to be weighing on the market again, despite the risks of a broader war.

Strong U.S. oil production has also reassured markets, with supplies from the world’s largest producer recently setting a monthly record, at just over 13 million barrels per day. “Strong oil market fundamentals are prevailing over any fears at this time,” said Jim Burkhard, vice president and head of oil markets, energy and mobility research at S&P Global Commodity Insights.

As the fighting continues, traders have realized that when it comes to oil, there are haves and have-nots in the Middle East. Gaza produces no oil and Israel produces little. For there to be a major disruption in supply, the effects of the war would have to spread to the giant oil fields of Saudi Arabia, Iraq or Iran.

Early in the conflict, Iran’s foreign minister called for an oil embargo against Israel, evoking memories of the oil embargo 50 years ago. But times have changed: given concerns about the role fossil fuels play in climate change and their dependence on oil for revenue, any such move would risk backfiring on the countries that imposed such a ban. Iran would risk distancing itself from China, the Islamic Republic’s key client.

“It is highly unlikely that the risk to supply comes from an independent decision to reduce oil sales by Iran or OPEC,” Eurasia Group said in a recent note. “Any such measure would cause as much, if not more, harm to producers as to consumers.”

A disruption is not inconceivable. Four years ago, a missile attack on a major Saudi facility — which U.S. officials blamed on Iran — temporarily knocked out about half of the kingdom’s oil production.

In an extreme case, Iran, Hamas’s main sponsor, could try to block the Strait of Hormuz, through which huge volumes of oil flow to the rest of the world. “I still think there is a considerable risk of this spreading,” said Helima Croft, head of commodities at RBC Capital Markets, an investment bank.

Croft said the apparent complacency about the impact of the war could be partly because traders lost money when prices rose above $120 a barrel after the Russian invasion of Ukraine, but then fell quickly.

“The market no longer has the capacity to deal with these types of issues,” he said.

Croft, a former Central Intelligence Agency analyst, said the apparent success of the early days of the 2003 invasion of Iraq by U.S. forces ultimately led to a conflict that dragged on for years. “We could still get a nasty surprise in the Middle East,” he said.

The Biden administration is trying to avoid an expansion of the war. Regional oil powers, including Iran, would also prefer to maintain tanker traffic through the Persian Gulf. Any disruption would hit its own export earnings, while price increases would risk harming and alienating its most valuable customers.

“The conflict is likely to remain contained and will not spread to the region’s large oil producers or key shipping lanes,” Energy Aspects’ Bronze said. “The risks come more from errors of calculation and judgment,” she added.