Energy market implications of the Israel-Hamas conflict

Q1: What was the immediate market impact?

A1: Brent crude prices rose to nearly $89 per barrel when Asian markets opened on Monday, before settling back a bit. Front-month Brent prices had dropped last week by some 11 percent from their late September peak, but oil prices have now regained some of that ground. However, the price bounce was relatively limited, suggesting that for now the market is not concerned about a major disruption to either supply or demand. Any conflict in the Middle East can create a geopolitical risk premium, but a more dramatic price impact may not materialize unless the conflict draws in other states and non-state actors. Israel has negligible oil output but is a sizeable natural gas producer. Following the attack, the country suspended production at its offshore Tamar gas field, which supplies the domestic market as well as Jordan and Egypt. Israel’s energy ministry noted that, if necessary, it could declare a state of emergency that would allow the government to allocate natural gas to various consumers in the event of supply shortages.

Q2: What would increase the oil market impact?

A2: Iran would be the vector for a broader market impact. So far, U.S. and Israeli officials have avoided blaming Iran for direct involvement in Hamas’s unprecedented attacks on Israeli civilians and military installations. But for years, Iran has supported both Hamas and Hezbollah to pressure Israel on multiple fronts as part of its “axis of resistance.” If evidence surfaces that Iran provided material or financial support for Hamas’s attacks, one obvious way to exact a toll is to ratchet up enforcement of sanctions on Iran’s oil exports. Between May and September of this year, Iran’s crude oil and condensate exports averaged some 1.4 million barrels per day (b/d), returning to levels not seen in at least four years. There is a widespread perception in the oil market that the United States has relaxed its sanctions enforcement on Iran as it negotiated over last month’s release of several political prisoners, among other issues. The uptick in Iran’s oil exports since May helped to offset deep production cuts by Saudi Arabia and other producers. If stronger sanctions enforcement curtails Iranian volumes in the fourth quarter of this year, anticipated supply deficits could grow even wider.

Q3: Will the United States dial up sanctions on Iran?

A3: As noted, policymakers have so far been careful to avoid accusing Iran of direct involvement in this weekend’s attacks. But any evidence of Iranian support in planning or financing the Hamas attacks would raise the pressure to toughen existing sanctions on Iran’s energy exports, or perhaps impose new penalties. Tougher enforcement may prove challenging. China now accounts for a large share of Iran’s oil exports, although black market practices obscure exact volumes. The key consumers of Iranian crude in China are not state-owned companies but so-called teapot refiners, or operators of independent refineries, largely in Shandong Province. Teapots took advantage of discounted Iranian crudes in recent months by ramping up imports. These refiners—some of which operate large facilities that belie the term “teapot”—have little exposure to the U.S. financial system and tend to operate outside the reach of U.S. and EU sanctions. The market has also become quite adept at sanctions evasion via ship-to-ship transfers, illicit practices such as turning off ship transponders or spoofing transmissions, and crude blending to disguise the origin of crudes. To ratchet up sanctions on Iran, the United States would have to change the calculus of Chinese buyers by leaning on the Chinese government and warning of stiffer enforcement actions.

Q4: How will this affect the broader region and OPEC+?

A4: It is difficult to tell how events will unfold in the months to come, but the conflict could easily spread to neighboring states, especially Lebanon and Iran. Israel has already shelled targets inside the Lebanese border and killed several fighters who allegedly crossed the border into Israel. Israeli strikes on Iranian targets are possible as well. When regional tensions are high and Iran feels cornered, it tends to lash out through attacks and sabotage of tankers in the Persian Gulf as well as support for non-state actors in Lebanon, the Palestinian territories, and Yemen. To be sure, Saudi-Iranian relations have improved of late, suggesting more potential to contain the fallout of regional conflicts.

For now, no major changes in oil market management are likely. Saudi Arabia and allied producers in the Organization of the Petroleum Exporting Countries (OPEC+) will probably monitor the impact of the ongoing events but avoid any decisions based on short-term volatility. But two possibilities could shift market management.

First, tougher sanctions enforcement, buyer wariness, or other factors that curtail Iranian exports in the fourth quarter could create pressure for Saudi Arabia to unwind its production cuts sooner than expected. Saudi Arabia recently extended its unilateral 1 million b/d cut through the end of 2023. But the combination of higher oil prices, plus concerns about inflationary impacts and weaker growth prospects in major consuming states, could add incentive for Saudi Arabia to bring more supplies into the market.

Second, the momentum toward a normalization of relations between Saudi Arabia and Israel is probably over for the time being. For months, Washington has been working to add Saudi Arabia to the list of Abraham Accords signatories. These talks involve complicated issues including Saudi demands for U.S. security guarantees and nuclear energy cooperation. The path to approval was already uncertain, given substantial criticism in Washington. But months of improved U.S.-Saudi dialogue cooled the tempers that flared in Washington after the October 2022 OPEC+ production cuts. When Saudi Arabia announced its unilateral production cuts beginning this July, following reductions by some OPEC+ states in April, the White House reaction was muted. Hamas’s attacks on Israel may not have been motivated by the prospect of Israeli-Saudi normalization. But it is hard to imagine how the talks could proceed in the face of an Israeli war on Hamas and potentially a ground invasion of Gaza. Putting these talks on ice will potentially make it harder for the White House to find a sympathetic audience in its calls to Riyadh.

Ben Cahill is a senior fellow with the Energy Security and Climate Change Program at the Center for Strategic and International Studies in Washington, D.C.

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