An Israel-Iran War May Not Rattle the Oil Market

The oil market is pushing its luck. For two years, it’s weathered unthinkable events, including volleys of direct attacks and counterattacks between Israel and Iran. Yet not a single barrel of production has been lost. With hindsight, every oil-price rally has proven to be an opportunity to sell. It required nerves of steel, but shorting crude while bombs and the missiles were flying was the winning trade.

The situation appears the same today after Israel launched a wide-scale attack against Iran, including its nuclear facilities, and Tehran warned of a “harsh” retaliation. Amid the chaos, the barrels are still flowing. Everywhere in the Middle East, oilfields were buzzing and tankers were loading on Friday. If anything, there’s still too much oil in the physical market, and prices, based solely on today’s supply and demand fundamentals, should retreat. But familiarity breeds contempt: the threat of a major oil Middle East shock is alarmingly high.

Real-time knowledge of the exact level of global supply and demand is impossible. But there’s a telltale: global inventories. And, for several months, those had been rising above seasonal norms, a sure indication of oversupply.

With Saudi Arabia pushing the OPEC+ cartel to boost production faster than previously expected and oil demand growth slowing, the imbalance was set to increase as the year progressed. The Northern hemisphere summer, which provides a seasonal lift to demand, is the last obstacle before an oil glut becomes plainly obvious. The Israeli attack hasn’t changed those supply and demand realities. Fatih Birol, the head of the International Energy Agency, spoke bluntly hours after the attacks: “Markets are well supplied today.”

If anything, the oversupply could worsen. On the demand side, geopolitical chaos is bad for business, so oil demand growth could slow even further. On the supply side, the current price rally – oil rose almost 10% in the initial hours after Israel launched its assault — is handing US shale producers an unexpected opportunity to lock-in forward prices, helping them to keep drilling higher than otherwise.

The biggest risk is sleepwalking into believing that just because two years of violence hasn’t disrupted flows, the physical market would never be disrupted. Particularly in the Middle East, it’s always the last straw that breaks the camel’s back. The global oil market looked well oversupplied in late July 1990; a week later, Saddam Hussein’s Iraq had invaded Kuwait, and the global economy was weathering a large oil shock.

On Friday, the energy market reaction has split between its two-year-old sense of we-have-been-here-before-and-nothing-happened and genuine alarm. In the initial hours, Brent rallied to almost $80 a barrel as every bearish position got covered. But it later pared its gains to trade around $75 a barrel as braver traders used the rally as a sell opportunity. Still, in the options market, where traders buy and sell insurance against sharp price moves, many were buying contracts that will make money if oil prices surge past $100 a barrel.