Oil prices fall but further escalation could see rates at $100 a barrel

Oil prices fell on Monday as market participants dialled back risk premiums following a weekend of escalated tensions in the Middle East.

Brent futures for June delivery fell 50 cents, or 0.5 per cent, to $89.95 a barrel by 0630 GMT, while US West Texas Intermediate (WTI) futures for May delivery were down 52 cents, or 0.6 per cent, at $85.14 a barrel.

“This was largely priced in the days leading up to it. Also the limited damage means that maybe Israel’s response will be more measured,” said Warren Patterson, head of commodities strategy at ING.

“But clearly, there is still plenty of uncertainty and it all depends on how Israel now responds.”

Analysts at Citi Research said prolonged tensions through the second quarter this year have largely priced oil at $85-$90 per barrel.

As the market has been broadly balanced in supply and demand throughout the first quarter, any de-escalation could see prices falling back quite sharply to the high $70s or low $80s per barrel range.

“What is not priced into the current market, in our view, is a potential continuation of a direct conflict between Iran and Israel, which we estimate could see oil prices trade up to over $100 per barrel depending on the nature of the events,” the Citi analysts said in a note.

Supply-side risks to oil production

As Iran currently produces over 3 million barrels per day (bpd) of crude oil as a major producer within the Organization of the Petroleum Exporting Countries (OPEC), supply risks include more strictly enforced oil sanctions and that an Israeli response could involve targeting Iran’s energy infrastructure, ING also said in a separate client note on Monday.

If there was significant supply loss, however, the US could release further crude oil from its strategic petroleum reserves, while OPEC has more than 5 million bpd of spare production capacity, it said.

“If prices were to rally significantly on the back of supply losses, one would imagine that the group would look to bring some of this spare capacity back onto the market. OPEC will not want to see prices going too high given the risk of demand destruction,” ING said in the note.

Oil benchmarks had risen on Friday in anticipation of a rise in tensions, touching their highest levels since October.

Oil prices

Analysts were widely expecting at least a short-lived rally in prices this morning, but said that more significant and longer-lasting price effects from the escalation would require a material disruption to supply, such as constraints on shipping in the Strait of Hormuz near Iran.

So far, the Israel conflict has had little tangible impact on oil supply.

“We don’t expect an immediate reaction in crude oil prices given ample spare capacity and an already elevated geopolitical risk premium,” said ANZ Research analysts in a note.

“Israel’s response will determine whether the escalation ends or continues. The conflict could still be contained. Only in an extreme case do we see it realistically impacting oil markets.”

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