Could war in the Gulf push oil to $100 a barrel?
Summary
- Missiles are flying over a region that supplies a third of the world’s crude
EVER SINCE Hamas’s attacks on Israel a year ago, the biggest fear in oil markets has been that tensions would escalate into a full-blown regional war pitting Israel against Iran, the world’s seventh-largest producer of crude. Until recently both countries seemed keen to avoid it. That explains why initial jitters on oil markets after October 7th last year soon gave way to the low and stable prices that have prevailed for much of this year.
But on October 1st Iran fired missiles at Israel in response to Israel’s pounding of Hizbullah and other Iranian proxies. Now the world is anxiously waiting for Israel’s response. Oil markets are nervous. Last week crude prices rose by 10%, to $78 a barrel, their biggest weekly gain in almost two years (see chart). As we published this, they were bobbing around $77. When the last war involving a major petrostate broke out, in Ukraine in 2022, crude surged past $100 a barrel. Could that happen again?
To understand how high prices might go, look first at Israel’s options for retaliation. If it struck only military targets, such as missile-launch sites—and Iran responded moderately—then some of the geopolitical premium boosting oil prices would evaporate. But Israel could choose to escalate by bombing Iran’s civilian infrastructure, oil and gas facilities or nuclear-enrichment sites. Whichever Israel chooses, Iran may feel forced into a robust response, triggering a cycle that ends up turning Iran’s petro-industrial complex, the regime’s lifeline, into a target. So oil assets need not come under fire first for global markets to fret.
If Israel attacks Iran’s oil facilities, it may target assets that transform Iran’s crude into petroleum products. One possible choice is the Abadan refinery, which provides the domestic market with 13% of its supply of petrol. The pain would remain local; such strikes may even boost the global crude supply as they could free up more of Iran’s unrefined oil for export.
If Israel wanted to deal a severe blow to Iran’s energy exports, it could go after the oil terminals on Kharg Island in the Persian Gulf—from which nine-tenths of all barrels of Iranian crude are shipped—or even the oilfields themselves. That would come at a diplomatic cost. The Biden administration would be annoyed that it might cause petrol prices to jump less than a month before America’s presidential election. China, the destination for nearly all Iran’s oil exports, would also be cross.
Israel might still deem the cost worth bearing, and opt for hitting the terminals. A successful strike would instantly take a decent pool of oil off international markets: last month Iran exported a record 2m barrels per day (bpd), equivalent to nearly 2% of world supply.
Even then, the global fallout would probably be contained. Unlike the situation after Russia’s invasion of Ukraine, when the world was pumping oil at full tilt and demand was rebounding after the pandemic, supply today is plentiful and demand sluggish. After a series of production cuts, the Organisation of the Petroleum Exporting Countries and its allies, collectively known as OPEC+, have more than 5m bpd in spare capacity—more than enough to make up for the loss of Iranian crude.
They probably wouldn’t wait long before raising output. OPEC+ members, angered to see their market share sliding in recent months, have been waiting for just such an opportunity to unwind their cuts. Last week they confirmed plans to lift output by 180,000 bpd every month for a year, starting in December. The Saudis are so determined not to cede further ground that they are said to have dropped their target of returning oil to $100 a barrel, the level required to balance the kingdom’s books as it launches several megaprojects.
Production is rising in America, Canada, Guyana, Brazil and elsewhere. The International Energy Agency expects non-OPEC output to grow by 1.5m bpd next year, more than enough to cover any rise in global demand. And demand is slowing on account of tepid economic growth in America, China and Europe and a race to ditch petrol cars for electric ones. Before the latest escalation in tensions in the Middle East, traders expected an oil glut in 2025, pushing prices below $70 a barrel. Today crude inventories in the OECD are below their five-year average. So a strike on Kharg Island would no doubt jolt markets. But prices would probably settle only $5-10 above their current levels.
Things could get much wilder if Iran lashed out at other Gulf states it sees as supporting Israel. In recent years relationships between Iran and its neighbours have been stabilising, and in recent days officials from Gulf Arab states have met Iranian counterparts in Qatar to try to reassure them of their neutrality. Still, with few options available, Iran may seek to target the oilfields of its neighbours—starting perhaps with smaller states such as Bahrain or Kuwait.
The other tool Iran could use to create global chaos would be to close the Hormuz Strait, through which 30% of the world’s seaborne crude and 20% of its liquid natural gas must pass. That, however, would amount to economic suicide, since it would leave Iran unable not just to ship out any oil or other exports but also to bring in many imports. And it would greatly annoy China, which gets about half its crude from Gulf countries.
It is hard to guess how the market would respond to such scenarios, if only because Iran’s actions would trigger further reactions from Israel, America and others. America and China, for example, would probably send their navies to reopen the Hormuz Strait. Still, assuming disruptions are big enough to cause shortages of crude that last for a while, then oil prices would probably climb to the point where they curbed appetite for oil, after which they would start falling. Analysts believe such “demand destruction" would occur once crude hit $130 a barrel—roughly the level it peaked at in 2022.
If oil markets believed such a scenario even remotely likely, their fears would start to be reflected in the current price. Traders who had bet on oil prices falling in the near future would be rushing to unwind their positions. Zoom out a little, however, and the recent rise in prices does not look striking, even by the relatively sedate standards of the past 18 months. Last year oil averaged $82 a barrel; in 2022, $100. The one-year-old conflict in the Middle East has confounded many expectations. But for oil prices to reach triple digits again, a lot of things still have to go very, very wrong.
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