Impact of Middle Eastern Conflicts on Global Oil Prices and Supply
This essay, based on S. Dinakar’s article “War and Price” in Business Standard (Oct. 04, 2024), examines how the ongoing conflict involving Iran, Israel, Hezbollah, and the U.S. has caused global uncertainty in oil prices due to fears of supply disruptions, economic slowdowns, and the strategic importance of the Strait of Hormuz. It also explores the historical and current impact of geopolitical tensions on oil markets, the risks of escalation, and the role of OPEC+ in stabilising prices during this volatility.
Introduction
Oil is one of the most critical resources for the global economy, powering industries, transportation, and daily life across the world. Events in oil-rich regions such as the Middle East have historically caused significant fluctuations in oil prices. The current conflict between Iran, Israel, and Hezbollah, with the involvement of the United States, is another such situation, raising concerns about oil supply disruptions. However, factors such as China’s weakened economy, increased production from non-OPEC nations, and strategic moves by OPEC+ are helping stabilise prices, at least for the moment. This essay delves into the impact of the conflict on global oil prices and the potential risks if the situation escalates further.
How Conflicts in the Middle East Affect Oil Prices
The Middle East is home to some of the largest oil reserves in the world, including countries like Saudi Arabia, Iran, and Iraq. Historically, wars and tensions in this region have led to sharp increases in oil prices. For example, during the Gulf War of 1990-91, oil prices skyrocketed when Iraq invaded Kuwait, leading to the destruction of key oil fields. Similarly, during the Iraq War of 2003, concerns over oil supply disruptions caused prices to spike.
The current conflict between Iran and Israel, with the involvement of Hezbollah and the United States, has raised similar concerns. Although oil supplies have not been directly disrupted yet, the fear of potential blockades or attacks on oil infrastructure has already caused oil prices to rise. This is primarily because countries that rely heavily on Middle Eastern oil worry about the possibility of a reduction in supply, which in turn causes a spike in oil prices.
Comparing the Current Conflict to Past Wars
The current tensions in the Middle East can be compared to previous conflicts such as the Suez Crisis of 1956-57, when Egyptian President Gamal Abdel Nasser seized the Suez Canal, blocking it for six months. This event took 10% of the world’s oil off the market, but prices remained stable due to production outside the region. Similarly, today’s conflict has not caused a significant spike in oil prices because global oil production is more diversified. Increased production from countries like Guyana, Brazil, and the United States has helped mitigate fears of shortages.
Another key factor in the current oil market is China’s economy. China is the world’s largest consumer of oil, and its demand for oil plays a huge role in determining global prices. However, China’s economy has been struggling recently. Manufacturing activity has slowed down, and the country’s economic growth has been weaker than expected. As a result, China’s demand for oil has decreased.
This decrease in demand has helped limit the rise in oil prices, despite the conflict in the Middle East. Normally, if China’s economy were stronger, it would be buying more oil, which would push prices higher. But with lower demand from China, the global oil market has been able to absorb some of the shocks caused by the conflict. However, if China’s economy starts to recover, and its demand for oil increases, prices could rise even further, especially if the situation in the Middle East worsens.
Potential Risks if the Iran-Israel Conflict Escalates
One of the biggest risks of this conflict escalating is the involvement of other regional powers. Iran has allies like Hezbollah and Syria, while Israel has strong backing from the United States. If the conflict draws in more countries, the risk of oil supply disruptions increases significantly. For instance, Iran has previously threatened to close the Strait of Hormuz, a crucial waterway through which about 20% of the world’s oil passes. Any blockade or military action in this strait would cause a severe disruption in global oil supplies, leading to a dramatic rise in prices
In addition to the potential closure of the Strait of Hormuz, there is also a risk of attacks on key oil infrastructure in the region. If countries like Saudi Arabia or Iraq are drawn into the conflict and their oil fields are targeted, the reduction in available oil would have a major impact on the global supply. This could lead to a repeat of the situation in 2019, when missile attacks on Saudi oil facilities caused oil prices to surge by 20%.
Importance of the Strait of Hormuz
The Strait of Hormuz is one of the most critical chokepoints for global oil supplies. This narrow waterway connects the Persian Gulf to the Arabian Sea and the wider world. Countries like Iran, Saudi Arabia, and Iraq rely on the Strait to export their oil to international markets. If Iran were to block the strait, it would cause a significant reduction in the global supply of oil. This would not only lead to higher prices but could also cause shortages in countries that rely heavily on oil imports.
While threats to the Strait of Hormuz have been made in the past, the current conflict has renewed fears that Iran might follow through. Experts believe that if the passageway is attacked or blocked, oil prices could spike as high as $140 per barrel before eventually stabilising at around $80-$90 per barrel. This would create massive economic disruptions, particularly for countries that are already struggling with inflation and other economic challenges.
Role of OPEC+ in Stabilising Oil Prices
During times of geopolitical tension, OPEC+ plays a critical role in stabilising oil prices. OPEC (the Organisation of the Petroleum Exporting Countries) is a group of oil-producing nations that work together to control the global supply of oil. OPEC+ includes OPEC members as well as additional oil-producing countries like Russia. Together, these nations decide how much oil to produce and sell on the global market.
OPEC+ tries to keep oil prices stable by adjusting the supply of oil. If prices are too low, they may cut production to raise them. If prices are too high, they may increase production to bring them down. In the current conflict, OPEC+ has so far managed to keep prices relatively stable by limiting production and ensuring that there is enough oil on the market to meet demand.
However, if the conflict leads to a major disruption in supply—such as an attack on oil facilities or the closure of the Strait of Hormuz—OPEC+ may not be able to prevent prices from spiking. In that case, the global oil market would face significant volatility, and prices could rise sharply.
Conclusion
The ongoing conflict between Iran, Israel, Hezbollah, and the United States has already caused oil prices to rise, even though there have been no major disruptions to supply yet. The potential for the conflict to escalate and involve other regional powers, such as through the closure of the Strait of Hormuz, poses a significant risk to global oil supplies and prices. At the same time, China’s weakened economy has helped limit the increase in oil prices by reducing demand.
OPEC+ continues to play a key role in stabilising prices by adjusting production levels, but it may not be able to prevent large price spikes if the conflict escalates further. Ultimately, the situation shows how interconnected the world is when it comes to oil markets, and how events in one region can have far-reaching consequences for the global economy. Understanding these connections is crucial for managing the risks and ensuring that global oil supplies remain stable.
