U.S. oil prices dropped below $74 per barrel in the past week, a sharp retreat from the surge caused by the early October surprise terrorist attack by Hamas on Israel and the ensuing war in the Middle East. Prices had surge following the attack due to concerns around escalation and potential tightening of U.S. sanctions on Iran.
Oil prices bounced after the Oct. 7 terrorist attacks and Prime Minister Benjamin Netanyahu's decision to declare Israel's first war since 1973. The risk that the war with Iran-backed Hamas in southern Israel would expand to fighting with Hezbollah, another Iran-backed group, on Israel's northern border with Lebanon, raised concerns that the U.S. would sanction Iran's exports. Oil traders acting on those concerns sent U.S. crude oil prices nearly 9% higher between Oct. 6 and Oct. 19, to more than $88 per barrel.
Iran's Forbidden Barrels
The war complicated the already long-running and delicate U.S. dance with Iran. On one side of those negotiations are concerns regarding Iran's desire for nuclear weapons and the risk of nuclear proliferation in the Middle East. Also, Iran's open backing of terrorist-labeled organizations, including Hamas and Hezbollah. And the periodic taking of U.S. hostages, and human rights abuses dictated by Iran's orthodox Islamic leadership.
On the other hand is the challenge of oil prices. Like Russia, Iran sees a large portion of its budget from oil export revenue. Amos Hochstein, White House energy adviser, on Wednesday told Bloomberg the U.S. planned to enforce sanctions against Iran, and that the measures would reduce Iran's oil exports.
Hochstein also explained part of the balancing act required in reaching the ultimate goal, which is reducing Iran's revenue. The "best antidote to revenues in Iran is keeping their exports at a lower level, but also to make sure prices are lower," Hochstein said.
Possible Oil Diplomacy
So far, the price portion of that antidote is in effect. U.S. oil dipped below $74 on Thursday, far below its pre-Oct. 7 levels. Exports are less clear. The Biden administration says it's been reviewing sanctions on Iran, Hamas and Hezbollah, the Lebanon-based militant group.
But it has made no clear moves to influence Iranian exports. The fact that President Biden on Wednesday spoke directly to China's Xi Jinping — president of the country who is Iran's top oil customer — and that Hochstein intimated sanctions may be in motion, may set the stage for a White House announcement.
With oil prices beaten down, it's unclear how much impact the loss of Iran's barrels might have. A political move reducing Iran's exports would almost certainly cause some increase. And any sizable increase could shake off the short sellers, pointing to a more pronounced move. Oil traders, investors and consumers are all watching closely to see how the situation plays out.
No Sanctions Yet
The price of West Texas Intermediate crude reached its highest level of the year, near $94 a barrel, in late September. At that point, U.S. oil producers had announced a series of production cuts, stockpiles were at low levels, and China's economy appeared to be climbing back on track.
Meanwhile, Iran's oil exports trended higher, averaging 1.35 million bpd in the third quarter, according to energy transport data provider Vortexa. The OPEC member's exports across all of 2022 averaged 832,000 bpd.
Just before Hamas invaded Israel, WTI prices had pulled back 13% from their September high and were leaning lower. But on the morning of Oct. 7, fears were high that Iran's oil was about to once again be stripped from the global supply.
Until Tuesday, the U.S. appeared averse to taking any action against Iran. The war premium imposed on oil prices diminished as global demand concerns again overtook supply worries. On Nov. 6, Bloomberg reported that the price of bullish call options in the oil market was no longer higher than bearish puts, a sign of crude's receding geopolitical-risk premium.
At that point, it had "become apparent that Iran wasn't going to be punished," said Matt Smith, lead oil analyst for the Americas at analyst firm Kpler. That made the situation in Israel-Palestine similar to that of a conflict in any other non-oil producing country.
"You have geopolitical risk, but it doesn't directly impact oil prices, because it doesn't directly impact oil supply," Smith told IBD.
On Again, Off Again Sanctions On Iran
Iran crude oil has been reentering the global market over the past couple of years as the U.S. and its partners continued to grind through negotiations with Iran over uranium enrichment and economic sanctions. Iran's sour crude barrels, used primarily for diesel and jet fuel, are also filling a market hole left by production cuts from the Organization of Petroleum Exporting Countries and its allies, including Russia, (OPEC+), according to Smith.
Estimates on Iranian current exports range from around 1 million to almost 2 million barrels per day. In 2015, six countries, including China and the U.S., plus the European Union, signed on to the Joint Comprehensive Plan of Action, commonly called the Iran nuclear deal. That deal freed Iran to export more oil in exchange for a number of concessions limiting its ability to develop nuclear weapons.
In 2018, President Donald Trump pulled out of the deal, reimposing oil export sanctions, while freeing Iran's nuclear program. The sanctions reduced Iran foreign crude oil sales to a low of around 400,000 barrels per day by 2020. The Biden administration began easing those restrictions, seeking a return to something like the 2015 deal.
A 'Laser Focus' On Pump Prices
Smith estimates Iran is currently exporting about 1.5 million barrels per day and that the country is producing up to 3.4 million barrels a day, a multiyear high. If U.S. sanctions on Iran successfully took its 1.5 million barrels per day off the global market, it could add $10 a barrel to oil prices, according to Smith.
Smith also said Iranian crude is keeping global supply steady and that with an upcoming election year in 2024, the Biden administration is "laser focused on keeping the price at the pump down."
On Tuesday, the Biden administration issued a four-month extension on a sanctions waiver that allows Iraq to continue purchasing electricity from Iran.
"The U.S. is very reluctant to cut off any supply of oil to the market," Smith said. "In fact, with Iran, it looks like they're seemingly turning a blind eye and letting Iran push more barrels onto the market."
China, Iran And Oil Prices
Iran's October oil exports fell to 1 million barrels per day, down from an average of around 1.4 million barrels per day over the previous six months, according to Kpler data. The firm speculated that tensions in the Middle East and the threat of stricter sanction enforcement by the U.S. could have turned off Chinese refiners.
The vast majority of Iranian crude, more than 90%, goes to China, according to Kpler. In the first 10 months of 2023, 91% of Iranian crude went to China with 6% exported to Syria, 2% to Venezuela and 1% going to "other" countries, Kpler reports.
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Abhi Rajendran, director of research & advisory at Energy Intelligence, said in an interview that while the Biden administration has maintained sanctions on Iran, it hasn't enforced them.
Rajendran added U.S. attempts to limit Iranian barrels on the market would be unlikely to make a huge impact with buyers like China and other countries that "fall outside the scope of sanctions anyway."
"The administration has been fine with that because it keeps supply in the market," Rajendran said. "You may see some more talk, but probably limited bite in terms of actually doing anything to take Iranian barrels off the market."
Chevron Flashes Risk Reduction Sign
Another sign of a lessened threat from the Israel-Hamas war on energy markets is Chevron's move to restart natural gas supplies to customers in Israel and the region from its Tamar gas field. Early on in the Middle East conflict, Israel ordered Chevron to shut down natural-gas production at one of its two offshore production platforms in the eastern Mediterranean.
Israel's natural gas flows to Egypt have now increased around 60% in November as concerns about escalation have retreated, Bloomberg reported Tuesday. However, gas imports to Egypt are still down from levels before the war began.
Oil Prices: The Middle East War's Risks and Unknowns
The war's risk premium to oil prices appears to have dissipated for now. However, analysts agree it could return based on the changing dynamics in the Middle East. Smith pointed to the possible blocking of the Suez Canal or the Strait of Hormuz as examples of major impacts on supply.
Since Oct. 7, the U.S. has deployed warships to the eastern Mediterranean. The Pentagon on Oct. 19 reported a Navy destroyer in the Red Sea shot down multiple missiles and drones launched "potentially toward targets in Israel." Meanwhile rockets have been fired from Lebanon and Israel has responded with retaliatory airstrikes.
At the end of October, the World Bank reported in its Commodity Markets Outlook that oil prices "would darken quickly if the conflict were to escalate." In a "large disruption" scenario, the global oil supply could shrink by 6 million-8 million barrels per day and prices could approach $140-$157 a barrel, according to the report.
Without any major escalation, Rajendran expects oil prices to recover to around $80-$90 per barrel over the next 12 months
"If the U.S. imposed sanctions on Iran, regardless of where those barrels are going, they'd be taken out of the global market and it would be supportive for prices," Smith said.
"It seems that the U.S. will be extremely reluctant to stymie the flow of that crude," he added.
Please follow Kit Norton on X, formerly known as Twitter, @KitNorton for more coverage.
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