Oil market puts Mideast geopolitical risk in the rearview mirror

The Gaza and Ukraine wars, which triggered supply worries that catapulted Brent futures to a year-to-date high settlement above $91/barrel on April 5, are still raging. But crude has shed a big chunk of the geopolitical risk premium in the weeks since, and might be headed for a period of relative calm, which could see Brent hovering in the low-$80s or sliding below the $80-mark, if a Gaza truce is clinched.

Although the Gaza crisis continues to fester, a few recent developments on that front have prompted the oil market to downgrade the potential risk of a wider Middle East conflagration threatening the region’s supply. It might seem counter-intuitive, but the flare-up in tensions between Israel and Iran through April has caused the recalibration.

Strategic region for oil production

It wasn’t so much what happened between the two regional rivals after Israel’s deadly attack on an Iranian consulate building in the Syrian capital of Damascus on April 1, as what did not happen. The tit-for-tat retribution that followed appeared designed to be a show of strength on the part of the attacker, but cause minimal damage to the enemy. Despite their amped-up rhetoric, Israel and Iran stayed well clear of the brink by not stoking an all-out military conflict.

Though there is no guarantee that the two won’t lock horns again and to potentially disastrous consequences, for the time being, their restraint has removed an ominous cloud of fear that was hanging over the oil market of the Gaza crisis spiralling out of control and disrupting oil and gas supplies from the Middle East. The region accounts for nearly every fourth barrel of oil pumped in the world and around 19% of its liquefied natural gas production.

Meanwhile, the Houthi rebels in Yemen remain intent on striking ships connected with Israel and its Western allies transiting through the Bab el-Mandeb strait and the Red Sea in support of the Palestinians, but this threat has also faded from market consciousness. The attacks have dropped in frequency. And though about 55% of crude and product tankers that would have normally transited through the Red Sea heading north or south continue to be diverted via the Cape of Good Hope, the market has absorbed the shift in flows, including the attendant increase in freight costs and shipping time.

When the naval chief of Islamic Revolutionary Guard Corps issued a public threat on April 9 that Iran could blockade the Strait of Hormuz if it so wished, the oil market did not take it seriously. Following Iran’s restraint in the face of Israeli attacks on its consulate and Isfahan last month, the market’s perceived risk of the vital chokepoint being blocked has receded further.

Negotiations over a Gaza ceasefire and hostage deal between Israel and Hamas, being brokered by the US, Qatar and Egypt, have proved tough, and despite renewed optimism of a breakthrough in recent days, sticking points continue to crop up.

But the fact that renewed obstacles in the truce talks have not prompted crude to reclaim any of the risk premium that it shed on hopes of a deal goes to show the market has discounted the fear of the situation deteriorating to the point of endangering oil flows from the Middle East.

ICE gasoil futures in a contango

Reports that the US is close to clinching a brand-new defence pact with Saudi Arabia as a precursor to the latter offering Israel diplomatic recognition in exchange for Tel Aviv making certain concessions on Gaza are also offering some relief, being seen as a longer-term game plan that might yield a more enduring peace in the Middle East.

Elsewhere, Ukraine has toned down its campaign of drone attacks on oil refineries deep in Russian territory, which it began at the start of this year and ramped up through March. Though Russia has suffered damage at several refineries and a drop in product exports, especially gasoil, the middle distillate is showing no signs of tightness. In Europe, the world’s major sink for gasoil, the benchmark ICE gasoil futures have been in a contango at the front end of the curve since mid-April, a sign of oversupply.

With the two key geopolitical concerns retreating to the wings, crude is poised to recouple with fundamentals. The evolving global economic outlook and OPEC/non-OPEC production policy will take over as key influences. The former is likely to revolve around the Federal Reserve’s monetary policy and market speculation on rate cuts, which typically guides risk appetite in the broader financial markets. As for OPEC+, there is less unpredictability over its path: with crude losing the risk premium prop, the producers’ group is likely to extend its production cuts when ministers next meet on June 1.

• Vandana Hari is the Founder and CEO of Vanda Insights. The opinions expressed in this article are those of the author and do not purport to reflect the opinions or views of Energy Connects or dmg events.