Since July, we expected oil prices would move upward, with the price of Brent crude reaching $90/bbl and OPEC+ remaining proactive in adjusting supply to counteract disappointing economic news and negative trader sentiment.

We also put forth the view that oil prices would not break through $100/bbl—not only because of continued concerns about the global economy, but also because of increased supply from producers outside of the OPEC+ quota system, including sanctioned producers (namely Venezuela and Iran). Additionally, we expected U.S. production to increase this year even with the decreasing rig count.

Therefore, considering our expectations for demand along with supply, our base case called for oil prices to moderate moving into the fourth quarter, in part because the gap between demand and supply would not be as great as some market participants were currently expecting.

We also have been highlighting that a major upside risk to oil prices stemmed from geopolitics that could result in disruption to oil production and oil movement—most notably from the Russia-Ukraine conflict and from the tensions between Iran and the U.S. The geopolitical risk became more tangible recently with the outbreak of the conflict between Israel and Hamas.

Prior to the initiation of the conflict in Israel, the dynamic of the last few weeks aligned with our expectations that the price of Brent crude would be under pressure and would test $90/bbl again. The price of Brent crude broke below $90/bbl during the first week of October, falling to $84.07/bbl before rebounding slightly at the end of the week.

The sharp drop-off in oil prices occurred even though the Joint Ministerial Monitoring Committee of OPEC+ announced (as expected) no change with respect to current production cuts. During that week, the sentiment of Brent oil traders continued to turn more bearish with net long positions decreasing by 10.35% after decreasing the prior week by 8.29%. The net long positions of traders of WTI also decreased, which broke the streak of four consecutive weeks of increases.

The dynamics of the oil market during the last few weeks, however, were disrupted by the initiation of the conflict in Israel, which had an immediate impact on oil prices with concerns that the conflict would expand beyond Israel, in part because Hamas took hostages that include citizens from Western countries, including the U.S.

Additionally, there have already been exchanges between Israel and with Hezbollah’s positions in Lebanon. The more significant risk of escalation is associated with Iran, which is a supporter of Hamas and Hezbollah. Additionally, prior to the attack, Iran had been increasing its efforts to disrupt shipping through the Strait of Hormuz, including seizing vessels and confronting U.S. Navy ships. To show support for Israel and to discourage outside actors from becoming involved, the U.S. has moved two aircraft carriers to the region. The situation is reaching a critical point as of the time of writing this, with Israel preparing for a military incursion into Gaza proceeded by a bombing campaign.

Where oil prices go next depends on how the conflict plays out. In the very short term, the price of Brent crude could test $95/bbl. If the conflict is contained and the threat to the flow of oil is mitigated, the risk premium will start eroding and the previous price dynamics will govern price movements.

The possibility remains, however, that the conflict could expand with the potential for the direct participation of Western countries. That scenario involves not only Iran, but could also draw in Russia and China, given that both have increased their ties with Iran during the last few years. China is a major buyer of Iran’s energy exports and Russia has been acquiring weapons from Iran.

Additionally, some politicians in the U.S. are trying to link the conflict in Israel with the conflict in Ukraine with the view that Iran is playing a central role in both conflicts. With this scenario, the price of Brent crude could test $115/bbl—and even go higher if there is a disruption to oil supply—either because of physical interference or because of an embargo imposed by oil producers in opposition to supporters of Israel.

The more hopeful scenario is still the most likely; however, the scenario depends on the following set of developments:

  • Israel exhibits restraint in addressing Hamas, in part, from pressure from the Biden administration along with public opinion;
  • Neither Iran nor the U.S. become directly involved in military conflict, even though there are some on both sides voicing support for such action;
  • Saudi Arabia does not support any calls for an oil embargo, but instead is willing to add supply if needed to stabilize the market;
  • Russia attempts to play a positive role in resolving the conflict, even though Russia has expressed support for Palestine (and Hamas) and is an ally of Iran; and
  • China continues monitoring the situation and encourages an equitable solution to the conflict.

Regardless, the conflict will be disconcerting with social unrest and trip wires that present the possibility of the situation spinning out of control.