What’s next as global oil markets navigate the return of risk premium

The Israel-Iran conflict continues to fuel geopolitical fears and obviously dominates any oil market headlines. While the missile barrage and air attacks are intense on both sides, a meaningful escalation seems contained so far. The adversaries’ allies, such as the United States, Russia, and other countries, remain on the sidelines. Oil & gas-related infrastructure remains spared, and trade routes are unaffected so far.

The US-Iran nuclear talks, mediated by Oman, were cancelled over the weekend. Of course, the situation remains in flux, with Iran’s regime seemingly under pressure in terms of reactions and options, which adds a level of unpredictability. Time will tell if this marks a turning point in Middle Eastern geopolitics.

The usual geopolitics playbook

For the time being, we stick to our best guess, that this conflict will follow the usual geopolitics playbook: a sentiment shock rather than a fundamental shock, with prices rising temporarily before returning to previous levels. The peak and duration of this pattern depends on the intensity of the conflict, but historically averaged below 20% in price gains and a length of up to three months.

In fact, the oil market seems to be remaining comparably calm, with oil prices not spiking much beyond Friday’s initial reaction so far. The market on Monday shows a lot of supply resilience. Storage is ample in the Western world and especially in China, where extensive oil inventories have been built over the past decade. The petro-nations, and especially Saudi Arabia, have plentiful spare production capacity, exceeding 5% of global output, which they have just begun to bring back to the market. Exports are incrementally growing outside of the Middle East, especially in South America.

A temporary risk premium

Demand is soft for economic and structural reasons, with the shift to electric vehicles eroding fuel demand in the Western world and China. The risk of closure of the Strait of Hormuz, a key choke point of oil trade, seems low. Iran needs the economic lifeline of oil exports, and such a move would alienate key oil buyers or allies on both sides, namely the United States, China, and India.

We stick to our neutral view but lifted our three-month price targets to US $72.50 last week to account for a temporary risk premium in prices. The fundamental long-term trends are unchanged, and the oil market remains on a twisted road to abundance, coupled with prices around $60. Geopolitics seems to be a distraction on this pathway for the time being.