The oil market has been performing a delicate balancing act all summer, with the threat of an escalating war in the Middle East on the one hand, and a slowdown in China’s economy on the other, exercising opposing forces on the oil futures market. Israel’s invasion of Lebanon and Iran’s retaliatory missile strike on Tuesday seem to be changing that equation.
President Joe Biden’s admission that the US has been discussing Israeli plans to specifically attack Iran’s oil infrastructure is prompting additional buying of oil futures. Were this to happen, there is every possibility that Iran could seek to close the Straits of Hormuz, cutting off a major route for oil and natural gas supplies to the rest of the world. This would cause energy futures prices to rocket.
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Crude remained underpinned Friday morning, with front WTI firmer for the fourth session in a row, and trading to one-month highs. “With the situation remaining incredibly fluid, and volatile, it seems unlikely that participants will have conviction to play crude from the short side at this juncture, with the balance of risks tilting towards further gains in the short-term, particularly as risk is hedged into the weekend,” said Michael Brown, a research strategist at CFD broker Pepperstone.
Brent crude futures trading up 8% on the week
Brent crude futures are anticipated to experience a weekly increase of approximately 8%, which would be the most significant since February 2023. Conversely, US crude futures are expected to experience a weekly increase of 8.2%, which would be the largest since March of last year.
Despite the fact that Biden has stated that he does not anticipate a “all-out war” in the Middle East, oil trading desk are focused on those Iran strike remarks, which may/may not include US assets.
“In spite of the fact that, oil prices have returned to the levels they were at just one month ago and oil has recovered from a low base, the pressure on world stocks and investors’ risk appetite is beginning to mount,” said Patrick Munnelly at Tickmill Group. “Should oil prices continue to increase and geopolitical tensions persist, investors may need to reevaluate their inflation forecasts.”
While no such strike has yet to be carried out, crude continues to – reasonably – price an elevated geopolitical risk premium, with front WTI rallying as much as 5% on the day Thursday, the biggest 1-day advance in almost a year, with the front contract touching its best levels in a month.
“Short crude, for now, still feels like something of a ‘widowmaker’ trade, given how fluid the situation in the Middle East remains; with the weekend on the horizon, I can’t imagine many wanting to run bearish oil exposures while markets are closed,” said Pepperstone’s Brown.
Fear stalks the equity derivatives market
In the equity derivatives space, meanwhile, further signs of nervousness are on offer. The VIX is happily residing north of the 20 figure, a level that analysts typically take to imply an elevated level of fear in the market, while the one-month S&P 500 skew shows put volatility trading at its highest premium over calls since early September, showing an increased demand for downside protection via options contracts.
However, the global supply and demand outlook could keep the bullish pressures in check to a certain extent. U.S. crude inventories rose while expectations pointed to a decline, showing some uncertainty regarding the demand in the US market. At the same time, OPEC has enough spare capacity to cover potential production losses from Iran if needed.
“A stronger supply situation could reassure market participants and help balance the impact of geopolitical risks to a certain extent,” observed Inki Cho, a financial markets strategist with Exness. “As a result, crude prices could remain volatile as traders react to new developments.”
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