Explained: what's next for energy markets after US strike on Iran?

Oil prices jumped to a five-month high on Monday as the weekend US airstrikes on Iran’s nuclear facilities stoked supply concerns and heightened focus on the Strait of Hormuz - through which passes about 20% of global oil and LNG supplies and around 66% of all sea-traded oil.

Global oil benchmark Brent crude jumped by 3% to $81.40 a barrel, its highest level since January, while US West Texas Intermediate (WTI) crude also advanced more than 3% to $78.40 at the start of trade on Monday. Both contracts pared the gains in subsequent trading sessions, indicating what analysts said was an increasing appetite to factor in the threat of geopolitical risks that often don’t morph into an actual supply crisis.

How high could the geopolitical risk premium go?

According to analysts, the current risk premium across energy markets and the shipping industry are driven more by geopolitical uncertainty rather than industry fundamentals in a phase in which Brent crude has climbed more than 14% this month.

While oil traders and investors are braced for higher prices, they seem to contend with no noticeable interruption to oil flows at present. But Goldman Sachs on Sunday cautioned that risks to global energy supply could lead to significant spikes in oil and natural gas prices. The bank estimated in a note that Brent crude could briefly peak at $110 per barrel if oil flows through the Strait of Hormuz were halved for a month and remained down by 10% for the following 11 months.

What are some of the viewpoints from analysts on the situation?

Most energy analysts have adopted a tempered approach to the crisis, pivoting on the lack of an immediate Iranian response to the US airstrikes. “Much depends on how Iran responds in the coming hours and days – but this could set us on a path toward $100 oil, if Iran responds as they have previously threatened to,” said Saul Kavonic, an energy analyst at MST Marquee. “This US attack could see a conflagration of the conflict to include Iran responding by targeting regional American interests that include Gulf oil infrastructure in places such as Iraq, or harassing passage through the Strait of Hormuz,” he told Bloomberg.

According to Jorge León, Head of Geopolitical Analysis at Rystad Energy, “a clear red line” has been crossed. “In an extreme scenario where Iran responds with direct strikes or targets regional oil infrastructure, oil prices will surge sharply,” he told the Financial Times. “Even in the absence of immediate retaliation, markets are likely to price in a higher geopolitical risk premium”.

Why were traders exiting futures positions even before the US airstrikes?

According to data from Bloomberg, global oil traders had been exiting futures positions at one of the fastest rates on record even before the US airstrikes – a barometer of higher levels of volatility on derivatives books, and the uncertain path ahead. 

In total, the number of futures contracts held on the main exchanges plunged by the equivalent of 367 million barrels, or about 7%, since the close on June. 12, the eve of Israel’s attack. Traders and brokers say the higher levels of volatility have made pricing deals harder over the past week, Bloomberg reported.

What’s the situation in the Strait of Hormuz now?

Amid an intense and volatile week ahead, the centre of attention is the Strait of Hormuz, the narrow waterway that’s the only point of entry to the Arabian Gulf.

While there have been no large scale deviations so far, on Sunday, two empty supertankers, each capable of hauling about 2 million barrels of crude, took an abrupt U-turn in the Strait of Hormuz and changed course, according to vessel tracking data compiled by Bloomberg. The latest deviations follow frequent instances of ships’ electronics and signals being jammed in the Gulf since Israeli airstrikes on June 13.

While the cost of hiring a ship to carry crude from the Middle East to China has jumped close to 90% since the Israeli attacks began, energy majors have signalled that they have contingency plans in place. “If that artery [Strait of Hormuz] is blocked, for whatever reason, it has a huge impact on global trade,” Shell CEO Wael Sawan said at the Japan Energy Summit & Exhibition in Tokyo last week. “We have plans in the eventuality that things deteriorate.”

What are the likely scenarios in the Strait of Hormuz and how secure are global energy supplies?

The Strait of Hormuz is a maritime chokepoint and a vital artery for not just Iranian shipments, but also for those from Saudi Arabia, Iraq, Kuwait and other members of the Organization of the Petroleum Exporting Countries (OPEC).

On Sunday, the Iranian Parliament voted to approve the closure of the Strait of Hormuz in response to the US and Israeli attacks, the country’s state-owned Press TV reported. However, the final decision on the closure of the Strait lies with Iran’s Supreme National Security Council.

Any attempt by Iran to close the Strait or disrupt operations would have profound implications on global trade and could send oil prices skyrocketing. But such an attempt would also prompt a coordinated response from the US – which counts on its navy’s Fifth Fleet stationed in Bahrain to ward off such a threat – and its global allies. It would also invoke the Gulf Cooperation Council (GCC) Defence Pact, under which Gulf states are obligated to collectively protect the security of its member states.

“The US is now positioned with an overwhelming defence posture in the region to be prepared for any Iran counter-attacks. But the risk for oil prices is the situation could escalate severely further,” Saul Kavonic, head of energy research at MST Financial, told the BBC.

Can OPEC+ and other global energy watchdogs help stabilise markets with additional reserves?

The decision last month by OPEC+ member states to raise production at accelerated rates would go a long way in assuaging the market amid uncertainty about the scale of the Middle East conflict, according to analysts.

Eight OPEC+ nations have expanded output by more than expected for three consecutive months, and are set to convene on July 6 to consider adding more barrels in August. In addition, OPEC+ members control a substantial share of the world's oil, with reserves estimated at over 1.2 trillion barrels, according to OPEC’s own publications.

The International Energy Agency (IEA) also counts 2.1 billion barrels in strategic reserves among its members, while US shale and new producers such as Guyana and Brazil could also offer supply relief in case of extreme price spikes.