Where would oil price be heading amid Middle East tensions?

Although oil prices have declined then afterwards managed to recover on Monday, geopolitical tensions might cause them to surge again, which would have repercussions in this year of significant elections. Traders are waiting for Israel to react to Iran’s recent direct attack, therefore they are on high alert. After falling by 0.9% on Friday, the price of Brent crude oil is 0.19% up to $89.66 on Monday. The price of West Texas Intermediate declined to $84.90 earlier on the day, but recovered to $85.26 per barrel at the time of writing.

Over the weekend, Iran launched over 300 drones and missiles into Israel, increasing its offensive force from earlier reliance on proxies in other nations. However, the effect on markets has been more muted than the headlines might suggest. Brent crude prices had risen to a six-month high of $92.18 a barrel on Friday after Israel’s allies warned of an Iranian attack in retaliation for an Israeli strike on an Iranian diplomatic building in Syria.

The recent attacks on Iran by Israel have not had any significant impact on oil supply, and the members of OPEC, the oil producers’ cartel, have spare capacity to produce another 6 million barrels a day. If they decide to use their spare capacity, they could drive prices down further. The United Arab Emirates has already pushed to increase OPEC production quotas, and US pressure to do so will intensify if tensions in the region continue to push up oil prices. An Israel-Iran war would be different, as Iran is a founding member of OPEC and produces about 3.2 million barrels of oil a day.

Although Iranian oil is under sanctions, any hits to production could still raise prices. In 2023, Iran was the world’s second-largest source of supply growth after the US, and any hit to this would surely raise prices. Citigroup analysts, led by Max Layton, wrote in a note to clients that oil prices could rise above $100 a barrel for the first time since the summer of 2022, shortly after Russia’s full-scale invasion of Ukraine sparked a global energy crisis.

Could prices drop back further if escalation ceases?

Oil prices are currently between $5 and $10 higher than they would be without concerns over supply disruption. The Middle East tensions are not showing signs of lessening, but if they do, the price premium could slowly fade, lowering prices further. However, Goldman analysts also noted several risks to prices, including OPEC’S members and Russia’s potential extension of production cuts as a political tool to keep prices high, damage to oil infrastructure, or interruption of the flow of oil through the Hormuz strait, which could cause a 20% price increase in one month.

Higher oil prices would be a challenge for central banks, as they consider when to cut interest rates as inflation falls back to their target levels. The International Monetary Fund warned against cutting rates too early, fearing inflationary pressures may still be acting on the richest economies. If oil prices rise, inflation could take longer to die down, making central bankers feel they have no choice but to delay rate cuts.