The influence of geopolitics always needs to be considered when assessing the outlook for the crude markets—especially developments such as the Israel-Hamas conflict.

In last month’s article, we highlighted that the direction of oil prices would be dependent on how the conflict developed because of the potential for the conflict to expand geographically into Syria and Lebanon and beyond, and to involve other countries, including the U.S. and allies on one side, and Iran and allies on the other side.

The involvement of Iran represents the greatest potential for triggering an interruption to oil flow—either through Iran’s actions to interfere with oil traffic associated with the Strait of Hormuz, or through the U.S. tightening sanctions on Iran’s oil-related exports. (Much less probable is the possibility of Iran, in conjunction with other producers, imposing an oil embargo on oil moving to western countries.)

With such an interruption, the price of Brent crude could test $115/bbl, and even go higher. We also stated that if the conflict is contained and the threat to flow of oil is mitigated, the risk premium would start eroding and the previous price dynamics would govern price movements.

So far, the conflict has been contained, with neither Iran nor the U.S. becoming directly involved in the military conflict and, as expected, the previous price dynamics have returned. Prior to the initiation of the conflict, the price of Brent crude was under pressure and had broken below $90/bbl during the first week of October, falling to $84.07/bbl.

The steep falloff happened with oil traders shifting from adding to their net long positions to reducing their long positions. From the start of the conflict on Oct. 7 through mid-November, the net long positions of Brent traders decreased by around 20% and are now back to the depressed levels seen prior to Saudi Arabia announcing the extension of its voluntary production cut of 1 MMbbl/d.

A dominant factor driving oil prices prior to the conflict was the concern about the global economy, with each of the major economies facing challenges. This concern is now back in the forefront:

  • The U.S. economy has been bolstered by strong consumer spending, but consumers have been depleting their savings while increasing their debt at the same time interest rates have been increasing. Additionally, the U.S. labor market is cooling down, with only 150,000 jobs being added in October and the unemployment rate ticking up. Furthermore, the U.S. manufacturing sector has been contracting for 12 consecutive months and the outlook for the service sector is deteriorating; 
  • Europe’s economy is forecasted to have negative growth in the fourth quarter after growth was essentially flat in the third quarter. Germany’s economic growth has lagged because of high energy costs and a tight labor market. Other major EU economies are also facing challenges, including Italy, which has a national debt that is 140% of annual economic output and interest rates (10-year bonds) that are 200 basis points higher than Germany’s; and 
  • China’s economy continues to struggle with disappointing consumer spending coupled with difficult exports markets. The debt-ridden property sector continues to face difficulties, including the housing market, even after the government took action to reduce downpayments for homebuyers. Additionally, during the third quarter, outflows of foreign direct investment in China were greater than the inflows of foreign direct investment for the first time since 1998. One reason for the negative net flows is the reduction in investment associated with U.S. companies.

Despite the economic concerns, we are still expecting the price of Brent crude to rebound back to around $90/bbl, in part, because the supply/demand fundamentals remain favorable. During the fourth quarter, we are forecasting that crude supply will increase in comparison with the third quarter with non-OPEC supply forecasted to increase by 1.1 MMbbl/d, while OPEC supply remains essentially unchanged.

However, we are also forecasting that oil demand will outpace supply by 870,000 bbl/d, even with the forecasted oil demand in the fourth quarter being around 400,000 bbl/d less in comparison to demand in the third quarter. Additionally, we expect that OPEC+ will continue to be proactive in managing supply to support oil prices. As such, we would not be surprised to see Saudi Arabia extend its voluntary production cut through first-quarter 2024.

Furthermore, while the oil market is currently dismissing geopolitical risks, we still think the possibility of the Israel-Hamas conflict progressing in an unpredictable manner exists—as does the possibility of oil prices spiking.