This Is Not Your Father’s Oil Crisis

The Hamas invasion of Israel will result in a long, chaotic, bloody conflict as Israel retaliates against Hamas and maybe also their sponsors in Iran. The death toll of both sides’ civilians is likely to climb sharply causing horror and angst around the world while enhancing the animosity on both sides. The geopolitical implications will be significant but are best addressed by the pertinent experts while I will stay in my lane and discuss the impact on oil markets.

Needless to say, the similarities with the first oil crisis in 1973 will suggest to many that a new oil price spike will occur, but this is not your father’s (or mother’s) oil crisis. Yes, a surprise attack caught Israel off guard, yes this is the Fiftieth Anniversary of the October War, but little else is the same. The first oil crisis (which was the Second Arab Oil Embargo) came after years of struggle between the oil companies that produced most of the oil in OPEC nations and their governments, with taxation, control and ownership contested. When some producers declared an oil embargo and production cutback in 1973, the market was already very tight after years of soaring demand, and the loss of oil supply combined with uncertainty about the duration of the war saw panic buying and a tripling of prices.

Without question, oil prices will be affected by the current conflict. Violence anywhere in the Middle East tends to raise tension in the oil market, even when it is far from any oil fields or indeed oil producing nations. Images of chaotic violence in Israel and Gaza will no doubt see investors buying into the market fearing the possibility of contagion, directly by, say, an Israeli attack on Iran, or indirectly through sympathetic production cutbacks by some exporters. But the volatility and higher prices are unlikely to be lasting, depending mostly on the response of oil producers and other governments, especially the U.S.

Almost everything that caused the price spikes in 1973/74 is absent this time and a number of positive changes will prevent massive price increases. First, while many people and nations support the Palestinians politically, few support Hamas and the current assault is unlikely to increase that. Iran, as the only oil exporter in Hamas’ corner, is not well-placed economically to reduce oil exports as a sign of solidarity, especially since they would almost certainly see others replace the lost supply.

But they might have no choice. It has been noted lately that the Biden Administration has appeared to be turning a blind eye to increased Iranian oil exports, up 600 tb/d in the first part of this year. Certainly, that will not continue and while they might maintain some exports, anticipate them to drop by at least 300-400 tb/d.

This will be bullish for prices, although nothing like 1973 either in the volume of oil displaced or the price impact. And the effect will depend on the Saudi response. Despite recent lessening of tensions between Saudi Arabia and Iran, the Saudis would hardly support Hamas and/or Iran in this episode, and quite possibly that they will provide political support to the Biden Administration and stability to the oil market by replacing any reduction in Iranian exports. That would be a replay of 2003, when Saudi production increased nearly 1.5 mb/d in only fourth months, as the figure shows.

Also, the present fragility of the world economy—with high inflation, growing labor actions, rising interest rates, a possible new round of covid and now continuous images of Middel East violence—can only be increased. Corporate investment and consumer spending could easily be reduced enough by political instability to trigger the recession that just a week ago appeared to be receding. Terrorist attacks, actual or feared, in Europe or the U.S. could also worsen consumer confidence. In other words, the tight market situation in 1973 is now turned on its head.

Fourth, the oil exporters are now fully in control of their oil industries and most eschew its use as a political weapon. After the 1970s, oil importers worked to reduce reliance on oil from regions perceived to be unstable of hostile. Granted, many attempts to substitute for Middle Eastern oil were abandoned as too difficult, but demand for OPEC oil nevertheless dropped by half in the early 1980s which served as a painful lesson about over-reaching. (Also, as I have said earlier, a lesson about relying on expert opinion.)

The 1973 Oil Crisis And The Experts’ Circular Firing Squad (forbes.com)

Third, while the market is now longer under the iron hand of the Seven Sisters, who actually worked in 1973 to reduce the embargo’s impact, the presence of a large spot market should reduce panic buying which was a major problem during both 1970s Oil Crises. It is possible that private oil sellers (traders and/or companies with surplus supply) will begin hoarding, but the threat to oil supply does not appear serious enough to cause that.

Finally, although there has been a large reduction in government strategic inventories in the past two years, dominated by the 300 million barrel drawdown in the United States, the OECD nations as a whole have a purported 1200 billion barrels in what the IEA calls “government-controlled stocks,” some of which are in private hands but under government regulation. Even so, given that any lost or threatened supplies should be relatively small, these inventories will be a Sword of Damocles over the heads of those tempted to bet on a big price spike. The longer term implications may be unclear, but the short-term threat to oil prices and the global economy should be moderate.