As Israeli troops moved into Lebanon and Iran launched a missile attack on Israel, the risk of a jump in oil prices that could trigger another global inflation shock appeared to be materialising.
Oil prices rose by more than 4% to about $75 a barrel on Tuesday.
However, experts said investors had remained relatively sanguine against a backdrop of escalating tensions in the Middle East, with oil prices having fallen more than 10% in the past three months and the US stock market remaining close to an all-time high.
Western financial capitals could be troubled by an uptick in oil prices, especially ahead of next month’s US presidential election. Inflation has cooled across advanced economies in recent months, paving the way for interest rate cuts by policymakers at the world’s top central banks.
Yet experts believe financial markets could still avoid panic, citing three key reasons: expectations for the future path of the Middle East conflict, geopolitics, and the increasingly shaky health of the world economy.
“It’s quite surprising when you see escalations and nothing moves, it’s not generally what you expect from markets,” said Nuwan Goonetilleke, the head of capital markets at the London-listed insurer Phoenix Group. “But it’s been escalating over the past 12 months.
“The market will continue to watch to see if the conflict draws in other regional powerhouses. Iran is the one that could be potentially dramatic.”
First, analysts remain hopeful that the recent escalation can be dialled back.
The stakes are high, however. Iran is a major oil producer, supplying about 3m barrels a day – or about 3% of world output – despite western sanctions.
Tehran has significant influence over the Strait of Hormuz, a key chokepoint for oil and gas tanker shipments handling as many as 20m barrels a day, almost 30% of the world oil trade.
Iran also exerts control over the Red Sea through its backing of Houthi rebels in Yemen, who have been targeting shipping. Earlier this year, this was among the biggest fears in global financial markets.
This is where geopolitics come in. Other major oil and gas exporters – including Saudi Arabia, Iraq, the UAE, Kuwait and Qatar – rely heavily on Hormuz, raising the prospect that Iran closing the chokepoint could have wider consequences.
Analysts at the consultancy Capital Economics said such a step could drive oil close to $100 a barrel. However, even if Iran restricted shipping, Tehran’s relatively warm relations with Qatar meant its supplies could still be allowed through. “In any case, given the likelihood of a military response – probably led by the US – we doubt that Iran would, in practice, be able to close the strait for long.”
After the 2022 Russian energy crisis, many countries moved to diversify energy supplies, including from renewables. Members of Opec+, a wider group of oil-producing nations including Russia, meeting on Wednesday are also expected to stick to plans to raise supply volumes. These include Saudi Arabia, the world’s largest producer, which has reportedly abandoned a $100 price target.
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Torbjörn Törnqvist, the chief executive of trading firm Gunvor, said he was “very confident” supplies would not be impacted, Reuters reported. “We have a situation around the Red Sea, Yemen, but by and large it’s more like a nuisance, but not really disruptive in any way,” he said.
The third factor that could avert a financial market panic is the economy itself.
Oil demand has sagged amid a slowdown in global growth – particularly in China, the world’s largest consumer, where Beijing is battling to revive flagging activity. European industry is also in the doldrums, with surveys on Tuesday showing factory output fell in September at the sharpest rate this year.
Demand in China had dipped to “a few hundred thousand barrels a day” from about 1.3m a day in 2023, according to Ole Hansen, the head of commodity strategy at Saxo Bank. “We believe these considerations point to a Brent crude price stuck in the $70s for the foreseeable future, with a geopolitical event or a recovering China the possible drivers of any upside surprise,” he said.
Two years ago the Russian energy shock came on top of an inflationary burst triggered by the easing of Covid restrictions and involving supply bottlenecks and red-hot demand from consumers eager to spend after lockdown.
This time, inflation is cooling and consumer demand is weaker, reflecting the toll on household finances from the recent period of fast-rising prices, and higher borrowing costs used in response to the shock.
Oil prices have fallen back from over $90 a barrel in April to about $70 – reflected in pump prices for motorists – helping further to ease inflationary pressures, at a time when the big focus in markets is on central banks cutting interest rates to avoid derailing economic growth.
However, further escalation in the Middle East could change all this. “We’re yet to see it, but escalating conflict would have more dramatic impact,” said Goonetilleke.