A Critical Juncture for Oil Prices

Events in the Middle East suggest far more than the “challenging days ahead” mentioned by Israeli Prime Minister Benjamin Netanyahu. Iran was humiliated by a security failure that allowed the assassination of Hamas political leader Ismail Haniyeh in Teheran.

“Iran (and Hezbollah) will either have to back down and lose face, or finesse an attack that looks significant but damages little – where any misfire will trigger the regional war so many have been concerned about, or just start that war regardless, even if this was not the timing they would have chosen.”

Michael Every

Clinically depressed oil markets have added a few dollars to over-sold futures prices. Experience indicates that this is normal, or is at least, the new normal. The initial phase of the market’s response to geopolitical tensions like these is to discount risk. Analysts expectations for large oil inventory draws in the third quarter of 2024 have been, after all, disappointing so far.

Last week, I explained why I was skeptical about a price rally based on supply and demand fundamentals. That was because oil markets are as close to balanced as disequilibrium systems can seem to be.

Figure 1 illustrates that the WTI price of $79.26 plotted on the long-term yield curve. Price was at its five-year average for the level of inventory recorded last week.

Put differently, the $5.00 risk premium from the second quarter of 2024 had been removed. Now, there’s every reason to expect that it will be re-instated in coming weeks assuming that Iran does nothing but rattle sabres.

“A price rally driven by geopolitical factors is more probable than one based solely on inventory or supply-demand fundamentals. Historical trends show that geopolitical events often trigger more substantial price movements than the gradual shifts in supply and demand.”

I’m Skeptical of the Higher Oil-Price Meme

All that a balanced oil market needs for higher prices is the threat of a good old-fashioned geopolitical risk in the Middle East. The assassination of Haniyeh in Teheran and Hezbollah’s chief of staff Fuad Shukr in Beirut may provide the price rally that analysts were anticipating for the wrong reasons.

Iran will act with a military strike against Israel. Israel has forced its hand. I sincerely hope that a broader, regional war can be avoided but its probability went up considerably this week.