The Middle East, where the Hamas-Israel conflict is centred, holds a significant portion of the world’s proven oil reserves, while it plays a crucial role in global energy markets as a major exporter of oil and natural gas. Based on Energy Institute’s data, the Middle East accounted for 33% of global oil production and 18% of gas production in 2022The Middle East, where the Hamas-Israel conflict is centred, holds a significant portion of the world’s proven oil reserves, while it plays a crucial role in global energy markets as a major exporter of oil and natural gas. Based on Energy Institute’s data, the Middle East accounted for 33% of global oil production and 18% of gas production in 2022.
In the wake of bloody attack by Hamas in Israel on October 7 and in the immediate post event period, European natural gas and global oil futures shot up by 14% and 4% respectively, reflecting wider uncertainty and fears of an intensifying conflict. Oil shot up because there are worries, again, that Iran might close the Strait of Hormuz, the chokepoint for nearly a third of seaborne oil. Natural gas prices went up firstly because Israel shut down a big offshore production platform in missile range of Gaza, and secondly because a pipeline in the Baltic mysteriously developed a hole, which Estonian officials attributed to “external” actors.
Even if Israel’s ground invasion into Gaza leads to an extended conflict, the impact on energy prices and the resultant OPEC response would depend on the scale and reach that the conflict takes. If it remains localised without affecting major oil producers or transit routes, prices may see limited immediate change, prompting OPEC to maintain current production levels.
The Monthly Analysis of October 2023, which is available here, attempts to shed light on the latest developments on the Hamas-Israel conflict and how it will affect the energy prices. Oil prices remain volatile and we expect upward pressures will remain while tensions in the Middle East persist and the risk of Iran becoming more directly involved in the conflict remains.
The price of natural gas is seeing a bigger impact. A key risk in the event of escalation would be the potential for an energy supply shock. While full-scale involvement of Hezbollah, would likely significantly increase risk premiums and volatility in financial markets, any potential oil supply disruption caused by sanctioning Iran and cutting off the exports of Iranian oil, currently about 2 million barrels per day, might be offset by Saudi Arabia given it has sufficient spare production capacity (about 3 million barrels per day). But this is not certain, as Saudi Arabia also wants to see a relatively strong global oil price.
The extreme tail risks for energy relate more to the possibility of Iran impeding transit through the Strait of Hormuz, the supply route for about 30% of the world's seaborne oil and one-fifth of global LNG supplies (mostly from Qatar) in a tight market. Yet, Europe also receives one-fifth of Qatar's exports (about 5% of the total European market) and its supply/demand balance has been very tight since Nordstream 1 closed in September 2022. Nevertheless, even in the absence of a material energy supply shock, the evident sensitivity in energy prices to recent events indicate that some inflationary pressures could persist through the Northern Hemisphere winter, particularly if supply disruptions of natural gas and LNG to Europe become more widespread.
