Dramatic change in oil prices: The surprising forecast in the shadow of Middle East tensions

Norbert Ruecker, Head of Economics and Next Generation Research at Julius Baer, conducted an economic review in which he addressed the new tension created in the Middle East with the mutual attacks between the United States and Iran, which in response also attacked other neighboring countries such as Jordan, Bahrain, the UAE, Kuwait, and Iraq, raising oil prices, but the fundamentals point to a decline.

Norbert Ruecker stated:

"The new conflicts in the Middle East have pushed oil prices back to 95 dollars. It seems that the conflict is stuck at a stage where the struggles for control over the Strait of Hormuz lead to recurring hostility, which fuels the risk premium embedded in oil prices. Beyond this noise and uncertainty, energy supply is holding up surprisingly well."

Oil inventories in Asia, Europe, and North America are abundant or show a narrowing deficit. This message, coming from inventory data, confirms the prevailing evidence of large quantities of oil flowing through the Strait of Hormuz, a trend that is expected to continue even after the current conflicts end. We remain in our cautious position and expect oil prices to fall to 70s levels this year and to 60s levels next year.

The conflicts of the last few days in the Middle East have raised oil prices towards 95 dollars per barrel. The central question now seems to be whether the latest tension will develop into a more serious escalation and a threat to global energy supply.

So far, it seems that things are proceeding according to the pattern of previous conflicts, which were temporary and without lasting consequences. The American attacks were intended to limit Iran's ability to interfere with shipping in the Strait of Hormuz. Iran's counter-attacks were mostly intercepted and aimed primarily at military infrastructure.

To our understanding, ships continued to enter and exit the Persian Gulf this week. Iran's military capabilities have been significantly damaged throughout the conflict, which allowed for the return of commercial traffic through Hormuz along the southern route, outside Tehran's control. This trade is mostly conducted at night and in convoys along secure routes.

Large quantities of oil are leaking through Hormuz, as pragmatism and opportunism are building up over time. Oil producers in the Middle East are accepting and managing the risks of the conflict primarily out of an economic need to restore oil trade.

Looking at another strait in the region, in the Red Sea, which Saudi Arabia depends on for its exports and to bypass Hormuz, it seems that the threats from Houthi attacks have also been contained so far. While the conflict continues and fuels energy markets with geopolitical uncertainty, oil and natural gas supply has so far proven surprisingly resilient.

Global oil inventories are sending a reassuring message. In Japan and South Korea, deficits have almost disappeared again. In Europe, inventories remained abundant throughout the conflict, even without using strategic reserves. In North America, the increase in exports drained inventories, but the deficit has begun to narrow since the summer.

The shortage that was feared in the past has not materialized, and the gaps are not widening. This confirms that the Middle East is still supplying large quantities of oil, except for Iran, which is suffering from the American blockade.

Certain parts of the oil market are still experiencing shortages. As refineries operate at full capacity, also for seasonal reasons, diesel margins and prices remain high. Overall, the fundamentals of the oil market point to lower oil prices.

However, it seems that the conflict is stuck at a stage where the struggles for control over the Strait of Hormuz lead to recurring hostility, which fuels the risk premium embedded in oil prices. We remain in our cautious position and expect oil prices to continue to fall in the near term. The mood in the market is too optimistic.