Oil prices dropped dramatically at the start of the week after Israel’s limited reaction to Iran’s missile attack convinced markets that a marked escalation in the conflict was unlikely.
Iran’s Supreme Leader Ayatollah Ali Khamenei then helped to cool tensions on Sunday when he signaled there would not be any direct response to Israel’s strikes in Iran.
The price of West Texas Intermediate tumbled from $71.78 on Friday to $68.01 early on Sunday morning before recovering slightly. Brent crude oil futures, meanwhile, fell from $76.05 on Friday to below $72 before bouncing back toward $73.
The geopolitical risk premium in oil markets climbed dramatically on October 1st when Iran fired almost 200 ballistic missiles at Iran in response to Israel killing Hamas’ political leader Ismail Haniyeh in Tehran.
After weeks of speculation about how Israel would respond, including reports that it might target oil and gas sites in Iran, the relatively limited scope of the attack on Saturday has helped cool tensions in the region.
At around 02:15 local time on Saturday, Israel carried out what it described as “precise and targeted” airstrikes on Iran. According to the BBC, “The targets included Iran’s air defences, as well as missile and drone production, and launch facilities.” The Iranian military confirmed that four soldiers had died during the attack.
The United States described the attack as an “exercise of self-defense” after President Biden had urged Israel not to target any oil infrastructure or nuclear facilities.
The day after the attack, Iran’s supreme leader signaled that any response from Iran would be measured, adding that “The viciousness of the Zionist regime should neither be overestimated nor underestimated”.
This relative cooling of tensions between Israel and Iran has reduced the risk of a major supply disruption in the region, leading oil markets to refocus on fundamentals. The fact that spare capacity remains high is only going to add to the downward pressure on oil prices.
Opinion in oil markets appears to be unified on the direction of prices in the short term, with Andy Lipow, president at Lipow Oil Associates, telling CNBC that it now “may be difficult to see Brent crude oil prices reaching $80 in the foreseeable future”.
ING’s Warren Patterson and Ewa Manthey as well as MST Marquee’s Saul Kavonic both see Israel’s limited attacks as opening the door to de-escalation. A de-escalation that will cause markets to refocus on surplus supply and lackluster demand.
Even before the latest developments, Goldman Sachs had warned that there was limited upside for oil prices in 2025, citing spare capacity and weak demand.
While the risk of a major supply disruption in the Middle East is by no means off the cards, expect demand - and particularly China’s economy - to be the focus of oil markets ahead of the U.S. election.
By Josh Owens for Oilprice.com
