If the intense conflict between Israel and Iran escalates, oil prices could reach $100 per barrel.
On June 13, the three major US stock indices fell sharply due to concerns about the conflict between Israel and Iran. Although there has been a lot of verbal sparring between these two countries over the past few decades, and there have been conflicts before, there is worry that this time it could elevate the situation to a whole new level of disaster. Any war, especially one that may require US intervention to defend allies, poses a downside risk to the market. The cost of war is high, not only in terms of loss of life but also in the wealth destroyed during the conflict.
For most aspects of the economy, an escalation of conflict in the Middle East would generally have negative effects. However, there are two industries that may rise due to the intensifying conflict: the first is the defense industry and the second is the Oil & Gas industry. In fact, despite the decline in major market indices, concerns about potential supply disruptions have pushed crude oil prices higher. On June 13 alone, crude oil prices surged by 7.6%, although at one point the increase was over 10%. This 'war premium' offers opportunities for oil investors, which at least somewhat alleviates the pressure the industry faced this year amid trade wars and broader economic concerns.
The conflict may escalate.
In an operation known as 'Operation Lion's Rise,' the Israeli government made a bold decision to deploy over 200 aircraft and drones to attack key military targets within Iran. This operation commenced in the early hours of June 13, primarily targeting nuclear facilities, but also involved the country's military, missile, and command centers, including the capital Tehran and several other cities.
During Trump's first term, he decided to terminate a successful agreement that had prevented Iran from further developing its nuclear capabilities. Although Iran complied with the agreement, he believed Iran's continued development of other capabilities and ongoing violent threats against the US and Israel were sufficient reasons for him to withdraw from the agreement and enforce harsh sanctions on Iran. Since then, there has been growing concern that Iran may further advance its nuclear capabilities and ultimately take significant military actions against the US and/or Israel. The final straw may have been the recent harsh criticisms from the International Atomic Energy Agency (the UN's nuclear oversight body) against Iran, as the country raised its uranium enrichment to 60% earlier this year, marking the first time in nearly 20 years that Iran has been found in violation of its non-proliferation obligations.
Israel's attack undoubtedly further escalated the situation. This is because Israel also launched additional attacks on other military bases, nuclear facilities, and the Mehrababad Airport on the outskirts of Tehran, prompting Iran to retaliate against Israel. Iran's retaliation involved numerous drone and ballistic missile launches, some of which resulted in casualties, and many missiles not only targeted Israel but also flew over Jordan, Syria, and Saudi Arabia. Additionally, the Houthis in Yemen also conducted actions against Jerusalem.
There is a risk of supply disruptions, and oil prices are trending upward.
These events and any further escalation will undoubtedly have a Bullish impact on the Oil & Gas Industry. During Trump's first term, the severe sanctions imposed on Iran drastically reduced the country's oil production. From 2017 to 2020, Iran's daily oil production fell from 4.76 million barrels to 3.01 million barrels, a drop of 36.8%. However, during the Biden administration, Iran's oil production began to recover. This was not due to the lifting of sanctions but because Iran became more flexible in oil Transportation and certain countries received temporary exemptions, allowing them to increase their purchases of Iranian oil exports. The end result is that last year, Iran's daily oil production rebounded to 4.68 million barrels.
The global oil market is in a delicate state of oversupply. As shown in the above chart, the global daily production and consumption of Crude Oil Product, as well as the surplus supply over the years. For instance, last year, global Crude Oil Product daily output exceeded daily consumption by about 0.06 million barrels. On its own, this number isn’t large. However, over a year, it amounts to an excess of 21.9 million barrels of Crude Oil Product. It is estimated that by 2025, the supply will exceed the demand by 0.82 million barrels per day, resulting in an additional 0.2993 billion barrels of Crude Oil Product. Forecasts from the US Energy Information Administration (EIA) suggest that next year the supply will exceed demand by 0.56 million barrels per day, which equates to an excess of 0.2044 billion barrels of Crude Oil Product.
The oil price situation is quite complex. Since the industry is primarily priced in USD, fluctuations in the value of the dollar against other currencies can impact prices. Concerns about economic conditions can also affect prices. However, it is noteworthy that a balanced oil market typically should have the commercial inventories of OECD member countries fluctuating between 50 to 60 days of supply. Once this range is exceeded, prices can experience significant volatility.
For example, in the following chart, the price of Crude Oil shows a certain inverse relationship with the commercial OECD inventories (measured in supply days). The increase in inventory days from 2013 to 2016 led to a corresponding decrease in prices. From 2017 to 2019, there was a decrease in inventory days while Crude Oil prices increased. In 2020, oil prices collapsed due to the COVID-19 pandemic, which was caused by a significant increase in commercial OECD inventories due to a steep decline in demand. By using estimated data from this year and next year, it's evident that the gradual increase in inventory days matches the decrease in prices.
The losses caused by supply disruptions due to Middle East conflicts could far exceed the current gap between global supply and demand. This is not only because of a possible reduction in Iranian oil production, but also due to the overall potential for supply interruptions in the region. This is related to the Persian Gulf and its Strait of Hormuz. This strait was referred to in 2023 as 'the most important oil passage in the world,' responsible for the transportation of approximately 20.5 million barrels of Crude Oil Product daily. This includes not only Iranian Crude Oil Product but also Crude Oil Product from Saudi Arabia, Kuwait, Iraq, and the UAE. Qatar is also affected, as the country, being the world's largest exporter of liquefied natural gas, transports almost all of its liquefied natural gas through this strait.
Overall, about 20% of the oil used globally each day is transported through this region. Given the strait's influence, Iran has consistently used it as a political bargaining chip. This includes actions taken in most years, including 2023, 2022, and 2021. Sometimes, these actions are relatively minor. However, in certain cases, such as in January 2021, the actions can be more significant. In that month, the Iranian government seized a South Korean-flagged oil tanker in the Gulf waters and detained its crew. In May 2019, four vessels, including two oil tankers owned by Saudi Arabia, were attacked outside the Strait of Hormuz. Some relevant countries can reroute part of their oil supplies around the region. But most oil cannot be rerouted. Through the decline in Iranian oil production and interruptions in maritime Transportation, even a reduction of 1 million barrels per day in global markets could theoretically lead to significant increases in oil prices. If full-scale war breaks out (a scenario that seems increasingly likely), it wouldn't be surprising to see Crude Oil prices rise to $100 per barrel or more.
Goldman Sachs Analysts raised the oil price forecast for the coming months last week, increasing it by $2 to $3 per barrel, but also listed a range of scenarios: the worst-case scenario could see oil prices surge above $100 per barrel. JPMorgan also predicts that the closure of the Strait of Hormuz could push international oil prices up to $130 per barrel.
Conclusion
Currently, for investors in the Oil & Gas Industry, this is a significant period. From every aspect, war is a bad thing. It consumes funds, takes lives, and can trigger various issues. However, for the Oil & Gas Industry, it has been under increasing pressure in recent months due to concerns that the global economy may decline because of the ongoing trade war. For those who are generally Bullish on oil, this may be a good time to consider investing, such as in oil and gas exploration companies.
Editor/Lee
