Middle East conflict: is natural gas replacing oil as the geopolitics barometer?

The sharper reaction to the war in the Middle East was seen in the price of natural gas. Prices spiked sharply this week, reviving fears of an energy crisis similar to that witnessed not so long ago. 

As trade in this super-chilled fuel grows, natural gas is becoming increasingly similar to oil in terms of globalisation and its role as a geopolitical shock absorber. However, it is too soon to consider natural gas to be a more relevant geopolitical indicator than oil. The Middle East is important for both, accounting for around a fifth of the total oil supply and a fifth of the seaborne gas supply. 

The ongoing disruption is stressful, but so far it is mainly affecting trade, with ships avoiding the Strait of Hormuz for precautionary reasons. However, oil and gas cannot be stored for long as the capacity of land storage facilities and ships in the Gulf is limited. The logjam is beginning to turn into a more significant supply disruption with production being shut down. Qatar’s natural gas liquefaction terminal is one of the first high-profile casualties of these dynamics. 

Unlike oil, for which there are a few pipelines linking production hubs directly to the Red Sea or Indian Ocean, natural gas has no alternative route to circumvent the Strait of Hormuz. This likely explains the sharper price reaction to the ongoing conflict. 

However, natural gas offers a different kind of flexibility with which to handle the supply disruption. Firstly, demand is dropping significantly as the northern hemisphere's winter heating season is coming to an end, which significantly reduces the immediate supply threat. Disruption delays the refill of storage, rather than emptying it. The market has some time to absorb the shock. 

Secondly, the loss of Qatari molecules can be compensated. As new terminals in North America and West Africa ramp up operations, at least half of the disruption could be offset by new supply. Today’s elevated prices will also likely increase the operational rates of existing terminals, maxing out the exports. The remainder comes from fuel flexibility on the demand side, largely from power plants shifting to coal. This is based on the assumption that the disruption continues for weeks or months, which is less likely. The intensity of the conflict increases its dynamics and the fog of war is dense, adding uncertainty and unpredictability. 

Recognising this, we are observing the conflict and its impact in various scenarios. Our base case is an intense, short-lived spike in energy prices, with oil prices peaking in the $80s to $90s and gas prices in the EUR 40s to 50s in March, before easing off in summer. There is no meaningful damage to energy infrastructure so far, Iran’s military strength appears to be weakening, and a solution to unclog trade around Hormuz by safeguarding shipping remains feasible. 

Oil trading in the $80s would not significantly impact consumers' household budgets at the fuel pump. Similarly, natural gas prices trading around EUR 50 should not result in a significant increase in electricity costs. A year ago, natural gas prices temporarily surged above EUR 60. 

Furthermore, with renewables dominating seasonally, at least in Europe, and natural gas power plants being called upon less frequently, the cost spike unleashed in the Middle East is partially offset before it hits industrial users and households. 

An energy crisis remains a distant tail risk scenario. It is worth keeping an eye on this tail risk, of course, as well as keeping an eye on where energy markets are heading. Regardless of the conflict's short-term trajectory, supplies will eventually return from the Middle East, Iran and Venezuela. Looking beyond today's intense conflict, the outlook of well-supplied energy markets with geopolitical threats easing rather than intensifying remains in place.