The tensions in the Middle East have highlighted the ebb and flow of the geopolitical risk premium in oil prices so far this month. Analysts believe that oil currently includes between $5 and $10 per barrel in premium to reflect a risk of escalation in the Israel-Iran conflict.
The past week has illustrated how traders perceive geopolitical risk. Just as Brent Crude prices had eased to the upper $80s after the Iranian drone attack against Israel in the April 13-14 weekend, oil spiked by 3% early on April 19 amid reports of an Israeli missile hit in Iran.
The fluctuating prices in response to the tensions in the Middle East show that traders continue to price in various degrees of escalation or de-escalation in the conflict on any given day or minute.
However, the current state of oil market fundamentals contains a few shock absorbers, as Reuters market analyst John Kemp noted in a commentary on Thursday.
Unless direct threats to oil production and oil exports from the Middle East appear, the market is expected to be able to absorb lower Iranian oil supply, be it from stricter U.S. sanctions or some disruption to Iran’s oil-producing capabilities, analysts reckon.
The reported Israeli missile hit rekindled fears of a broader escalation, but so far, no oil supply from the Middle East has been directly threatened.
Moreover, the market is in such a shape right now that it has the highest spare capacity in years and a build-up of commercial stocks has emerged this month. These should offset some of the geopolitical risk that has been lingering in the market since the Hamas attack on Israel last October.
Analysts estimate that OPEC+, which is once again firmly back in control of the oil market, is sitting on a spare capacity of about 5 million barrels per day (bpd) of oil production that can be returned gradually in case of severe tightness in markets and a surge in oil prices above $100 per barrel.
That’s the highest spare capacity at OPEC since the 2009 recession, except for 2020, when the pandemic crushed oil demand and prices, and global producers held back 10 million bpd from the market.
The OPEC+ group could influence oil prices by returning some of the 2 million bpd supply it is currently keeping off the market—unless, of course, the Strait of Hormuz is blocked for oil tanker traffic, which would cripple oil exports of all Middle Eastern producers, including Iran.
A major disruption in the Strait of Hormuz is a ‘low probability’ event, according to analysts.
“Oil prices are likely to reflect some of these risks with a geopolitical risk premium in the coming months, but we think we’d need to see meaningful escalation to see a pronounced spike to 2022 highs of $125 per barrel from today’s $90 per barrel,” JP Morgan said earlier this week.
Then, there are commercial stock builds that act as a bearish drag on prices.
While U.S. commercial stocks are just below the five-year average for this time of year, there has been a bearish trend of builds so far this month, including an inventory build of 5.8 million barrels for the week to April 5, and an inventory increase of 2.7 million barrels for the week to April 12, per EIA estimates.
U.S. crude oil stocks have risen to a ten-month high, “raising some doubts about the current level of demand,” Saxo Bank said in a market commentary on Thursday.
The bearish stock trend continues in the United States, with the current build so far this month more than 13 million barrels above the five-year average build in April, consultancy FGE said in a Friday note.
“Most notably, total US commercial crude and product stocks are 3 mmb higher than a year earlier, having been 40 mmb lower y-o-y in mid-March,” FGE noted.
The high spare capacity of OPEC+, recent stock builds in major markets, and further increases in non-OPEC+ production this year could cushion the price impact of the Middle East tensions. Barring an actual disruption to supply, these ‘shock absorbers’ may keep oil from spiking to $100.
By Tsvetana Paraskova for Oilprice.com