How the Israel-Hamas War Could Careen Into Oil Markets

What starts in Israel can turn the global energy market upside down. That’s a lesson from the 1973 Yom Kippur War, which started almost exactly 50 years ago with a surprise attack by Egypt and Syria on Israel and helped kick off an embargo from Arab members of the Organization of Petroleum Exporting Countries to punish the United States for supporting the Israeli military.

But despite the superficial similarities between the two conflicts, few analysts expect spiraling oil prices — at least not yet.

“Neither Israel nor its direct neighbors are large oil producers. Hence, we judge the near-term risk to oil supply as limited,” Morgan Stanley analysts wrote in a note to clients. “That could change in case the conflict were to extend to other countries in the region.”

The risk to oil supplies largely stem from how the conflict in Gaza affects oil-producing nations in the Middle East, namely Saudi Arabia and Iran.

“The big risk to oil is the odds of the conflict escalating into the Persian Gulf. There could be disruption to oil flows stemming from a U.S. or Israeli escalation against Iran, if it becomes clear that Iran was directly involved in the conflict,” Eurasia Group analyst Greg Brew told me. “That could come in the form of a U.S. crackdown on Iran oil exports — which the U.S. has been disinclined to do this year — which would trigger an Iranian response in the Persian Gulf.”

Rory Johnston, founder of Commodity Context, said that up to one million barrels per day of Iranian exports were at risk if Israel and the United States determined Iran was responsible for the attacks and responded accordingly. “Will Israel attack Iranian infrastructure in retaliation? U.S. sanctions enforcement has been weak over the past year as part of a suite of efforts aimed at getting Iran back in some kind of nuclear deal — does that reverse?”

“If the U.S. or Israel decides to take the fight to Iran, [it] would spin things out in a way that would disrupt oil flows and push prices upward,” Brew told me.

The other major player is Saudi Arabia, which was in the process of negotiating a U.S.-brokered deal to formally recognize Israel, which would be a tectonic shift in the politics of the Middle East.

Last week, oil prices actually declined meaningfully thanks to optimism about the Saudi-Israeli-American deal. The Wall Street Journal reported on Friday that “Saudi Arabia has told the White House it would be willing to boost oil production early next year if crude prices are high,” explicitly in order to help pave the way for a deal with Israel.

Earlier this year, Saudi Arabia announced that it would cut production down by a million barrels a day to nine million, a move which immediately raised suspicions that it would, intentionally or not, damage the Biden administration by leading to a hike in gas prices. Towards the end of last year, average gas prices fell as low as $3.09 per gallon, before rising to $3.87 in August. They are around $3.80 today.

The Biden administration has been trying to navigate twin goals of containing consumer prices — including for gasoline — and transitioning away from fossil fuels. Alongside the unprecedented investments in clean energy from the Inflation Reduction Act, this has meant using federal policy to lower gasoline prices by releasing oil from the Strategic Petroleum Reserve last year and then trying to bolster U.S. production in the short term by buying oil at prices just above the breakeven price for profitable drilling.

Last Wednesday, OPEC announced that Saudi Arabia and Russia would maintain its previously announced production cuts through the end of this year. Prices for Brent crude went over $96 a barrel late last month and then fell to $84 by the end of the last week, before jumping up to around $87.50 today.

“At least part of last week’s…selloff was the news that the Saudis were negotiating with the Biden admin officials regarding Riyadh officially recognizing Israel, and as part of that deal Saudis were saying that they might ease the current production cuts early next year,” Johnston told me.

“Hard to imagine that the prospects of such a deal remain as strong given what we know Israel is going to do in Gaza in retaliation. Indeed, wedging Israel and Saudi exactly like this is one of the working theories for Iran’s possible involvement.”

At least so far, Israel and the United States have been cautious about blaming Iran for the attacks, thus likely limiting fears that the global energy market will spin out of control. For now.