Crude oil prices tend to be sensitive to the outbreak of political tensions and war, but they don’t react in any sort of systematic way to these events. There is no rule of thumb to help you figure out what the likely impact of a given conflict will be on the commodity’s prices. Many of the dynamics that will drive prices up or down, or keep them steady, are specific to the region and the circumstances in question, which need to be carefully analyzed.
When conflicts arise in countries like Russia, Israel, China, or Venezuela, crude oil prices usually spike in response. This is because oil is produced in these locations or, as in the case of Israel, because tensions involving this nation pose a threat to oil supplies held by her neighbor and enemy, Iran. Oil refiners react, in these cases, as if supplies were under threat and go on a buying spree to make sure they have as much of the commodity as they need. More demand means higher prices.
Still, the upward price pressure doesn’t normally last for long. On average, Brent crude oil appreciates by 0.8% to 1.5% in a knee-jerk response to the hostilities, after which it subsides – unless oil infrastructure is damaged, or an export embargo is established to cut off supplies to elsewhere. Why should the price spike be only temporary? Because the conflicts themselves are commonly short-lived, and because supplies can be secured from other sources.
When we move away from oil-producing corners of the globe, different patterns emerge. In fact, prices mostly display the opposite dynamic and head groundward. Why should that be the case? Join us for another minute or two to find out.
Demand Shock
When the USA or a non-oil producer is one of the parties touched by a conflict, crude oil prices, for the most part, stay put in the near term but then drop by about 1.2% after one financial quarter. As long as there’s no apparent threat to supplies, oil traders exhibit a different, bearish reaction to geopolitical tension. Since the conflict seems to threaten the economic outlooks of the parties involved and their trading partners, not to mention the disruptions to international trade that might result from armed hostilities, the dominant concern surrounds a widespread demand shock.
In other words, traders worry that economic activity will slow down, consumer sentiment will weaken, and that oil demand will suffer in consequence. Remember: It isn’t just demand for gasoline that affects prices in the arena of crude oil investing. Plastic, rubber, asphalt, and many chemicals are made from crude oil. Consumers may cut back on purchasing all these items if the economic backdrop suddenly takes a turn for the worse. Thus, we see a temporary dip in prices materialize in the weeks following a military confrontation.
Israel and Iran
These two contrary dynamics in the reactions of oil prices to geopolitical tensions are evident in the developing hostilities in the Middle East since October 7th, 2023. When news broke of Hamas’s terrorist attacks in Israel, oil did not respond with any sustained price gains. Almost exactly a year later, on October 1st, 2024, Iran attacked Israel with a barrage of ballistic missiles, and this did trigger a sharp leap in oil prices. What was the difference between the two incidents?
The first one didn’t appear to threaten oil supplies in any direct way, while the second one did. As the October days passed in 2024, the possibility of an Israeli revenge attack on Iran’s oil plants or nuclear facilities was a live concern. These eventualities could spark off a genuine war in the region, which would put local oil infrastructure under direct theat. The reason for the supply risk is that 4% of the world’s oil comes out of Iran and, even though this isn’t a huge portion, historical battles in the region have triggered large price increases. For instance, in the aftermath of the Yom Kippur War of 1973, oil prices leapt from $3 a barrel all the way to $12 a barrel. The supply scare, then, worked to push prices upward in early October 2024.
Towards the end of October, Israel’s response came. Their choice to avoid hitting oil or nuclear plants in Iran deflated the supply risk rapidly, so that crude oil fell by as much as 5%. Oil bulls had lost “one of their few sources of support”, in the words of Michael Brown of Pepertone and, “particularly with the demand outlook still rather bleak”, it was understandable that prices would recoil in this way.
The root cause of the tepid demand scenario was China’s economic stagnation, which bode badly for their upcoming consumption trends. In September, revenues from Chinese industry were as much as 27.1% below the previous year’s levels, and this confirmed the seriousness of their predicament. In addition to this, OPEC (the Organization of Petroleum Exporting Countries) had promised to soon taper off the production cuts they had been maintaining since 2022. Increased supplies would also function to depress prices.
Wrapping Up
One factor that can dampen the effect of supply risks in our times is America’s improved production capacity. The steady stream of oil flowing through their pipelines has recently shown its power to stabilize the market. According to Todd Staples of the Texas Oil and Gas Association, this is what explains the minimal reaction in oil prices to the 2019 Houthi attack on a Saudi Arabian oil refinery.
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