An Israel-Iran war may not rattle the oil market

Yet, not a single barrel of production has been lost. With hindsight, every oil-price rally has proven to be an opportunity to sell. It required nerves of steel, but shorting crude while bombs and the missiles were flying was the winning trade.

The situation appears the same today after Israel launched a wide-scale attack against Iran, including its nuclear facilities, and Tehran warned of a “harsh” retaliation. 

Also Read: Counter-intuitive: Why Opec wants lower oil prices

Amid the chaos, the barrels are still flowing. Everywhere in the Middle East, oilfields were buzzing and tankers were loading on Friday. If anything, there’s still too much oil in the physical market, and prices, based solely on today’s supply and demand fundamentals, should retreat. 

But familiarity breeds contempt: the threat of a major oil Middle East shock is alarmingly high.

Real-time knowledge of the exact level of global supply and demand is impossible. But there’s a telltale: global inventories. And, for several months, those had been rising above seasonal norms, a sure indication of oversupply.

With Saudi Arabia pushing the OPEC+ cartel to boost production faster than previously expected and oil demand growth slowing, the imbalance was set to increase as the year progressed. 

Also Read: The war in West Asia is escalating, so why aren’t oil prices shooting up?

The Northern hemisphere summer, which provides a seasonal lift to demand, is the last obstacle before an oil glut becomes plainly obvious. The Israeli attack hasn’t changed those supply and demand realities. Fatih Birol, the head of the International Energy Agency, spoke bluntly hours after the attacks: “Markets are well supplied today.”

If anything, the oversupply could worsen. On the demand side, geopolitical chaos is bad for business, so oil demand growth could slow even further. 

On the supply side, the current price rally—oil rose almost 10% in the initial hours after Israel launched its assault—is handing US shale producers an unexpected opportunity to lock-in forward prices, helping them to keep drilling higher than otherwise.

The biggest risk is sleepwalking into believing that just because two years of violence hasn’t disrupted flows, the physical market would never be disrupted. 

Particularly in the Middle East, it’s always the last straw that breaks the camel’s back. The global oil market looked well oversupplied in late July 1990; a week later, Saddam Hussein’s Iraq had invaded Kuwait, and the global economy was weathering a large oil shock. 

Also Read: Escalating Israel-Iran conflict to keep markets on boil in near term

On Friday, the energy market reaction has split between its two-year-old sense of we-have-been-here-before-and-nothing-happened and genuine alarm. 

In the initial hours, Brent rallied to almost $80 a barrel as every bearish position got covered. But it later pared its gains to trade around $75 a barrel as braver traders used the rally as a sell opportunity. Still, in the options market, where traders buy and sell insurance against sharp price moves, many were buying contracts that will make money if oil prices surge past $100 a barrel. 

Israel hasn’t yet targeted Iranian oil installations so perhaps the biggest risk of supply losses can be averted. But the important word here is “yet.”

President Donald Trump is allergic to high energy prices, which will probably restrain Israel Prime Minister Benjamin Netanyahu, who would otherwise love to blow up the oilfields that fund the Iranian nuclear programme. 

On Thursday, hours before the attack, Trump spoke publicly about his unhappiness with the recent move above $70 a barrel. In a public event, he rhetorically asked Secretary of Energy Chris Wright: “Are we OK? Nothing wrong? Right? It’s going to keep going down, right? Because we have inflation under control.” Well, not any longer. 

Tehran hasn’t yet threatened to return to its old playbook of showering fire over the Saudi oilfields and close the Strait of Hormuz, the shipping chokepoint for 20% of the world’s oil supply. 

Also Read: Israel goes to war without Trump. The US may be drawn in anyway

But here again, the key word is “yet.” To understand how risky the situation is, listen to everyone around Iran. Saudi Arabia and its neighbors are trying very hard not to give Tehran a pretext to attack them. Hence why Riyadh—and several others in the region—quickly condemned the Israeli attack. Don’t misunderstand the Arab condemnation as sympathy toward Tehran; it’s all about minimizing blowback. 

The two biggest risks for the oil market stem from Iranian weakness. First, if Tehran concludes that the only way to restore deterrence against Israel is to accelerate its efforts to build a nuclear bomb, sanctions are likely to follow. 

The Islamic Republic perhaps could withdraw from the 1968 nuclear non-proliferation treaty, but that would probably prompt United Nations sanctions that would make Chinese purchases of Iranian oil, running at more than 1.5 million barrels a day, more difficult, if not impossible. 

Second, as bombs rain on the Islamic Republic, the sense that Ayatollah Ali Khamenei isn’t just fighting to keep his nuclear programme but to preserve his own regime is rising. If Tehran concludes it’s defenseless and is fighting a war for survival, it’s likely to conclude that triggering economic upheaval via the oil market is a useful card to play.

So even though there’s plenty of crude and oversupply is evident, it will take nerves of steel to short the oil market. ©Bloomberg

The author is a Bloomberg Opinion columnist covering energy and commodities.