(Bloomberg) — Iran’s missile attack on Israel is testing widely held bearish views on oil prices, with the strike raising concerns over potential supply disruptions from the Middle East should tensions increase further.
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Prime Minister Benjamin Netanyahu has threatened to retaliate to the barrage, and there’s a risk that could spur a tit-for-tat escalation. Brent crude surged more than 5% following the assault Tuesday, before paring some of those gains. Oil rose again Wednesday to trade above $74 a barrel.
Still, the market hasn’t fully priced in the risk of a further jump in prices in the event of attacks on Iranian oil facilities, or if Tehran blocks the Strait of Hormuz, according to analysts and traders.
The latest developments come after money managers and hedge funds held the most bearish stance on oil on record late last month on worries about demand and oversupply. OPEC+ is poised to restore more output from December, while drillers outside the alliance are also ramping up production, leaving the market with plenty of wiggle room before running out of barrels.
“The crude market was extremely short and complacent about geopolitical risk,” said Bob McNally, president of Rapidan Energy Group and an adviser in the George W. Bush administration. “The crude risk premium would only rise if the market saw an escalation that directly impacted energy infrastructure or flows, or if Israel attacked regime-threatening critical infrastructure.”
The strike by Iran, which produces more than 3 million barrels a day of oil, was a reprisal after Israel carried out a series of attacks on Lebanon in recent days. The OPEC producer had also threatened to retaliate after the political leader of Hamas was killed in Tehran in July — an attack blamed on Israel.
Oil could climb as much as $7 a barrel if the US and its allies placed economic sanctions on Iran, or by $13 should Israel strike Iranian energy infrastructure, according to preliminary estimates from Clearview Energy Partners. A disruption to flows through the Strait of Hormuz could have the biggest impact, driving crude $13 to $28 higher, the firm said.
Oil Choke Point
The Strait of Hormuz is a narrow waterway at the mouth of the Persian Gulf, which handles almost 30% of the world’s oil trade. Its shallow depth make ships vulnerable to mines, and its close proximity to Iran leaves tankers open to attack from missiles or interception by patrol boats.
“While Israel may have a superior advantage militarily, Iran may utilize its geographical advantage to disrupt the key shipping route at the Strait of Hormuz,” said Yeap Jun Rong, a market strategist for IG Asia Pte in Singapore. “In this case, oil prices will surge.”
In the event of major and prolonged disruptions in the Middle East, the US is likely to tap its strategic petroleum reserve, according to traders and analysts. The stockpile currently holds about 383 million barrels, which provides a significant cushion.
As geopolitical risk premiums return, there is also growing concern that prices will whipsaw as many traders stay on the sidelines waiting for the dust to settle, leaving the market more vulnerable to algorithm-driven traders that have grown in prominence lately.
Commodity trading advisers have grown into a formidable presence in oil markets in recent years, and their trend-following trading style often amplifies price moves in both directions, making it harder for traders with physical exposure to navigate the market.
–With assistance from Ari Natter, Kevin Crowley and Yongchang Chin.
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