Oil prices are on track for their most significant weekly surge in nearly two years, driven by fears that Israel may launch strikes on Iranian oil infrastructure in retaliation for a missile attack on its territory.
West Texas Intermediate crude edged higher on Friday to more than US$75 a barrel, following a nearly five per cent rally the previous day after U.S. President Joe Biden indicated that the U.S. was deliberating potential support for Israeli strikes on Iranian energy facilities. A U.S. official later clarified that discussions were ongoing with Israel and no final decision had been reached.
Crude prices have spiked nearly nine per cent this week amid concerns over a potential disruption to oil supplies from the Middle East. The region accounts for approximately one-third of the world’s crude oil production, with Iran alone producing around 3.3 million barrels per day in recent months.
Oil market watchers agree that if retaliation from Israel targets Iran’s oil infrastructure, it will have a major impact on the market.
“I do think Israel will be respectful of global concerns about an oil price shock when it conducts its retaliation. However, Israel is in a three-eyes-for-one-eye mode,” said Bob McNally, president of Rapidan Energy Group.
“They are going to hit Iran big, but I think they will probably avoid, at least in this first round, the facilities that enable the 1.8 million barrels a day of crude that Iran has been exporting. But Israel has been surprising everybody by acting more aggressively than everyone expected. So, if I am wrong, it’s probably in the direction of a bigger hit to oil.”
300,000 to 1.5 million barrels per day at risk
Analysts at Citigroup Inc. estimate that a major Israeli strike on Iran’s oil export capacity could reduce global supply by 1.5 million barrels per day. Even a limited strike could take 300,000 to 450,000 barrels off the market.
“Iran’s (oil) production last year was one of the strongest sources of growth in the market,” said Rory Johnston, founder of Commodity Context. That production has quietly rebounded despite years of U.S. sanctions, reaching near full capacity — a surge in supply that is now under threat as tensions with Israel intensify.
Over the past two years, Iran’s crude output has increased by one-third to 3.3 million barrels per day on average, driven by discounted sales primarily to Chinese buyers, according to data from Bloomberg. This level is only a few hundred thousand barrels short of what the country was pumping out prior to sanctions that former U.S. president Donald Trump imposed in 2018.
Iran’s ability to sustain this oil output has been facilitated by the tacit tolerance of the Biden administration. In the run-up to the 2024 elections, the White House has prioritized keeping domestic fuel prices in check over strict enforcement of sanctions. However, the escalating military conflict now threatens this supply.
Oil market will impact other sectors
The crisis has also impacted the shipping sector, with oil tanker earnings rising since the latest escalation. Additionally, Iran appears to have repositioned some of its vessels away from a key oil loading terminal, reflecting heightened caution amid the ongoing tension.
Concerns are also mounting over the possibility that Iran could respond to any Israeli retaliation by targeting energy infrastructure in neighbouring countries or disrupting supply routes. McNally raised the possibility of an attack on Azerbaijan – an oil-producing ally of Israel that Iran has threatened in the past. And Clearview Energy Partners warned that any significant disruption to traffic through the critical Strait of Hormuz could push crude prices up by $13 to $28 per barrel.
While this geopolitical tension has spiked prices based on what might happen in the future, the oil market is amply supplied based on conditions right now. OPEC+ plans to restore some of its shuttered capacity in December, while Libya has resumed production after resolving political standoffs. Additionally, U.S. crude inventories unexpectedly rose by nearly 3.9 million barrels last week, adding to the overall supply picture.
Despite the short-term rally, analysts like Citigroup’s Eric Lee have suggested that the market is still capped due to OPEC+ holding back significant spare capacity; currently at around six million barrels per day. This spare capacity, if restored, could place a ceiling on further price spikes, barring any substantial geopolitical escalation.