Iran’s Attack Is Already Priced Into Oil Prices

We believe the Iranian drone and missile attack on Israel over the weekend places some additional stress on the oil markets. However, we also think the ample public and private forewarning from Iran amid rising regional tensions means the attack was already reflected in oil prices via a higher geopolitical risk premium.

We attribute nearly all the increase in oil prices (to around $91 a barrel from the mid-70s in February) to geopolitical concerns rather than supply risks. On the supply side, Saudi Arabia and OPEC+ have about 5 million barrels per day of supply (if not more) that can be returned to the markets if prices overheat and spike above $100 a barrel. We expect more downside risks than upside at the moment, and see a higher potential to touch $75 by the end of 2024 versus a sustained movement beyond $100 a barrel.

We warned in our Oct. 9, 2023 note that the major risk for the oil markets remains a direct escalation of hostilities between Iran and Israel. This is not that scenario. We see it as a more limited retaliation for the earlier Israeli strike on the Iranian embassy in Syria. Iran has stated that with this attack, it considers the matter complete.

While we consider tensions in the region somewhat combustible, Saudi Arabia and Iran recently restored diplomatic ties. This suggests we are far from a scenario similar to the one that led to the 2019 attack on the Saudi Abqaiq oil facility, which temporarily shut down more than half of the country’s oil production. The United States and other Group 7 countries are urging Israel to consider its defense against the strike as a success and not retaliate.

The risks to the oil markets remain material if the situation escalates further. Iranian oil production was about 3.1 million barrels per day as of February 2024. Increased US economic sanctions against the country could reduce that amount by 500,000 barrels per day of production. A more dangerous scenario would be an Iranian attempt to close the Hormuz Strait, which handles about 30% of the world’s crude, mostly heading for Asia.

We also think US increases in oil production are an increasing counterweight to a potential conflagration in the Middle East. In December 2023, US oil production was 13.3 million barrels per day, based on data from the US Energy Information Administration, compared with 8 million barrels per day in December 2013. This production should act as a relatively stable source of calm for the markets. On the other hand, the Biden administration has one fewer lever to pull with the Strategic Petroleum Reserve. At 362 million barrels, the inventory has yet to be restocked to 2021 levels of over 600 million barrels.