Oil Price Geopolitical Risk Premium Deflates

Geopolitical risk plays a vital role in influencing the price of crude oil in the global market. The relationship between geopolitical risk and crude oil prices is complex and multifaceted. Understanding this connection is crucial for oil market participants and investors to make informed decisions.

The risk was always the spread of the Israeli-Hamas Conflict to the wider Middle East. Military positioning (US aircraft carriers) by the US and intense diplomatic efforts with Arab allies have calmed down the situation.

In addition, Iran and its main proxy Hezbollah have distanced themselves from being involved in the planning of the Hamas attack, at least the operational aspect of it. Both have praised the attack but seem to have been surprised at the scale. The statement by the Hezbollah leader praised the attack but fell short of actually committing to a military escalation with Israel. Below, we take a look Iran and its proxies in the Middle East to argue that widing the conflict is not likely.

Hezbollah: the economic situation in Lebanon is a domestic constraint on escalation with Israel. This key Iranian proxy would loose fighters and support with Lebanon at this time. In addition, Iran uses Hezbollah as a threat in case Israel were to launch a hypothetical nuclear strike on Iran. Therefore, Iran does not want its main proxy to be degraded.

Iraqi Proxies: Iran can direct these militias to attack US bases but this could put Iran in direct conflict with the US military. Thus, expect this to be low level with the US also cautious to not destabalize the current Iraqi government. Both the US and Iran are unlikely to go too far here since there are clear red lines and escalation would be very costly.

Syrian Proxies: the US has greater flexibility to attack Iranian proxies in Syria since escalation risk here is low.

Yemeni Houthis: the US does not want to get dragged into more involvement here although both Saudi Arabia and the UAE would benefit if it were to happen. Thus, I expect that Israel and US warships to shoot down any missles coming from Yemen.

Finally, both Iran and the US do not want direct military conflict.

Primer: Geopolitical Tension in the Middle East and Oil Market

There are three main areas where Middle East tensions on the geopolitical front can impact oil prices. The key thing to remember is the two main competing blocs in the Persian Gulf area. On one side you have Iran against the Gulf countries led by Saudi Arabia. The US provides a security umbrella for the Gulf states. This results in what is called the geopolitical risk premium which is just an additional price on top of oil price to compensate for preceived political risk.

First, Iran’s geopolitical dynamics and its impact on the oil market have been a subject of global interest. Tensions involving Iran can lead to concerns about potential disruptions in oil supplies and affect market sentiment, influencing the price of oil in the international market. Thus statements by the Iranian regime threating Isreal or Saudi Arabia move prices. Also, threats made by Israel or US against Iran impact the oil market etc.

Second, tensions in the Middle East contribute to market volatility and uncertainties within the oil sector. The region’s geopolitical landscape holds significance for global oil markets, and any developments in the Middle East can have immediate repercussions on oil prices and supply dynamics. This increases the geopolitical risk premium.

Finally, threats to oil supply and transportation disruptions, particularly in the Middle East, can disrupt oil supply chains and introduce heightened uncertainties into the global oil market. The potential disruption of oil supplies from the region can trigger market responses and impact the overall stability of the oil market. For example, attacks on oil tankers in the Persian Gulf have an impact on oil supply perceptions.