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Oil market moves higher as stakes increase in Middle East

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Regular readers of The Armchair Trader will have read my predictions for 2024. As part of that I said I anticipated further geopolitical volatility in the Middle East, that it had scope to dominate headlines in 2024, and that for commodities traders there existed a strong possibility that we could see a sudden oil spike to $100/bbl.

An attack by Iraqi militants using drones on a US base in Jordan over the weekend is just the sort of escalation in activity I was talking about in our forecast. Oil prices have responded accordingly. At time of writing, Brent crude is trading at $84 with WTI Crude at $77.

Bear in mind there are still significant pressures on the other side of the oil trade, in terms of the slowdown in growth in China, and just as importantly, the change in the character of Chinese oil imports. The oil market has long grown used to significant demand for energy supplies from China, but if that demand slackens off, it will have a continual depressive effect on oil. It IS slackening off, but in new and unusual ways.

China reported record imports of crude oil in 1H 2023, but a lot of that is coming out of Russia and Iran.  Imports from Russia increased by 23% in 2023. China is also buying a lot more of its oil from Brazil than it used to. It looks to be insulating itself from supply disruptions in the Middle East. If anything, it seems as if European countries are now more exposed to energy price volatility. But Chinese buying activity is not having the same impact it used to have in oil futures.

How will Middle East conflict affect the oil market?

Iran seems to be pushing hard for a confrontation with the US using its proxies in Yemen, Iraq and Lebanon, and this will cause oil prices to move higher. As the market does not have access to Iran’s playbook, it makes predicting the next move very difficult.

“Many investors are now pursuing a more cautious approach, with heightened risk aversion impacting various asset classes,” observed Nigel Green of deVere Group this morning. “The Middle East remains a crucial player in the global energy market, accounting for a significant portion of the world’s oil production. Disturbances in the region have a profound impact on energy prices. The attacks on a fuel tanker in the Red Sea have already triggered concerns among oil traders, prompting a reassessment of the risks associated with shipping cargo through the area.”


Risk premium in crude oil picking up this morning

“Certainly we are seeing geopolitical risk premium in crude prices this morning though as ever I’d caution that this is wont to relinquish control as long as nothing else happens to worry traders,” said Neil Wilson, Chief Market Analyst at Finalto. “But we also had some very bullish inventory data last week.”

There is more supply coming online, as Wilson hints at, and that is what many other energy analysts are also focused on in a week which could see some very choppy trading conditions in an oil market that is becoming increasingly news-driven.

“I believe the resumption of production at the Libyan oil field, after a two-week halt, will reintroduce over a million barrels per day into the markets, significantly increasing supply and potentially causing a sharp decline in prices,” said Rania Gule, a market analyst with XS.com in Dubai. “Chinese oil data shows that Russia has become the primary supplier to the Asian country, potentially weakening Chinese demand due to its relative satisfaction with Russian oil, further supporting a medium to long-term price decrease.”

This comes after a Chinese demand increase of 8.6% to 14.24 million barrels per day. Following China’s decision to keep its key lending rates unchanged and market expectations for more easing to support the economy, Chinese oil demand may decline yet further in the coming months, supporting market declines. But this would require the news flow from the Middle East to slacken off. I don’t think that will happen.

Despite some current downward pressures, ongoing geopolitical tensions in the Red Sea and the Gulf of Aden maintain significant risk premium support for oil prices. The price movement in the market is also reflected in the spread between the current Brent price and its futures contracts for the next six months, indicating expectations of potential oil supply constraints in the future.

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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