The latest escalation in tensions in Iran has paved the way for the return of risk premiums on oil prices once again.
At one point on Friday, Brent crude oil prices had jumped more than $8 per barrel to hit its highest level since late January.
Israel initiated strikes on early Friday, targeting Iranian nuclear facilities and military objectives.
These attacks come at a time when the US and Iran are holding ongoing nuclear talks.
While recent discussions showed little progress and a wide gap between both sides, talks were scheduled to resume this weekend.
However, given the latest developments, it’s uncertain if they will proceed. The US has also clarified its non-involvement in the strikes against Iran.
“This is a significant escalation and differs from the strikes we saw last year, which spared Iranian nuclear sites,” Warren Patterson, head of commodities strategy at ING Group, said in a note.
This escalation will only exacerbate uncertainty and heighten the risk of disruptions to regional energy supplies.
“While there are no reports of disruptions to oil supply, the market needs to start pricing in a larger risk premium,” Patterson added.
How much supply is at risk?
Iran is a meaningful oil producer, pumping more than 3 million barrels per day of crude oil, according to data from the Organization of the Petroleum Exporting Countries.
The country also exports in the neighbourhood of 1.7 million barrels daily, according to ING.
“In a scenario where we see further escalation, it’s not too difficult to envisage a situation where Iranian oil supplies are disrupted,” Patterson said.
Most of Iran’s oil exports are gobbled up by China. However, recent data from Bloomberg showed that Iran’s exports to China fell below the 1 million barrels per day mark for the first time in six months in May.
Carsten Fritsch, commodity analyst at Commerzbank AG, said recently:
Due to tighter US sanctions, independent refineries are also likely to have refrained from importing Iranian oil, even if there is no official data on this from China.
Nevertheless, if oil exports from Iran are affected, it could send the oil market into a deficit from a surplus in the second half of the year, ING said.
“This scenario could see Brent spiking to $80/bbl, although we believe prices will likely settle around $75/bbl,” Patterson added.
The Strait of Hormuz route at risk
Continued escalation could disrupt shipping in the Strait of Hormuz as well, which is an important route for trade.
The Strait of Hormuz is a critical chokepoint for global oil supplies, with nearly a third of all seaborne oil trade passing through it. Any disruption to this strait would significantly affect oil flows from the Persian Gulf.
Patterson said:
While some portion of oil flows could be diverted to avoid the Strait, it still leaves roughly 14m b/d of oil supply at risk.
Prices could reach $120 per barrel if these flows are significantly disrupted, according to him. Additionally, if these disruptions persist through the end of the year, prices could even hit record levels of $150 a barrel.
Disruptions to shipping via the Strait of Hormuz could severely impact the global LNG market as well.
Qatar, accounting for approximately 20% of global LNG trade, relies entirely on this route for its exports, lacking any alternative.
Such a scenario would drastically tighten the global LNG market, leading to a substantial increase in European gas prices.
Making up any supply shortfall
Should significant supply disruptions occur, governments globally would likely access their strategic petroleum reserves.
This initiative would undoubtedly be spearheaded by the US, given its strategic petroleum reserve holds over 400 million barrels of crude oil.
An alternative solution involves OPEC utilising its spare production capacity, which exceeds 5 million barrels per day.
While OPEC is already in the process of restoring supply, a disruption to Iranian supply could accelerate the pace at which this capacity is brought online.
Eight members of OPEC+, including Saudi Arabia and Russia have been increasing production by 411,000 barrels a day since May. It is scheduled to raise output by the same amount in July as well.
The summer months of May to August provide strong demand fundamentals, which supports such increases from OPEC. However, experts at Rystad Energy believe that post these months, the market would struggle to absorb such increases.
“The only way OPEC+’s increase is possible is either if there is significant disruption in supply somewhere or non-OPEC+’s growth stalls,” Priya Walia, vice president, oil at Rystad Energy had said in a recent emailed commentary.
However, she also said that the actual increases in OPEC+ production is much less.
Overall, our estimates indicate that the actual flow of expert barrels is likely to be lower than announced production increases, which would lead to real impacts on the market.
Further complications
While OPEC can cushion the market against a loss of Iranian oil supply, the situation becomes more challenging if tensions escalate.
Most of the spare production capacity is located in the Persian Gulf.
“So, if we are seeing disruptions to oil flows through the Strait of Hormuz, this spare production capacity will be of little help to the global oil market,” ING’s Patterson said.
Due to the Strait’s critical role, any disruptions would necessitate a globally coordinated effort to maintain consistent energy flow through this vital chokepoint.
At the time of writing, the price of West Texas Intermediate crude oil was around $73.63 per barrel, up more than 8%. Brent prices on the Intercontinental Exchange was up 8% at $74.77 a barrel, its highest level since January.
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