The shadow of Hormuz: Why oil prices are finally reacting to Middle East crisis

Oil is no longer insulated from the volatile situation in the Middle East. After weeks of stagnation, with crude prices at their lowest point in almost three years, Iran’s involvement in the conflict has rekindled fears that regional tensions could trigger Israeli strikes on Iranian oil facilities or provoke Tehran to attack Saudi oil fields or refineries, as happened in September 2019. The most alarming scenario would be the closure of the Strait of Hormuz, a critical passage for one-fifth of the world’s crude oil. A blockade of this 21-mile stretch between Iran and Oman would significantly disrupt oil prices.

Market observers have been puzzled by how oil prices have remained stable, despite the escalating conflict, especially given that the Middle East accounts for one in three barrels of oil produced globally. “Historically, this lack of price movement is truly strange,” said Jorge León, vice president and head of oil analysis at Rystad Energy.

“A year ago, the mere conflict between Israel and Lebanon would have sent prices soaring into triple digits,” said Norbert Rücker, head of economic research at Julius Baer, just hours before Iran launched 200 missiles at Israeli territory, prompting a $4 spike in Brent prices within two days.

Markets have been banking on two factors: that the situation wouldn’t escalate further and that OPEC’s substantial spare capacity — its highest in years — could offset any production cuts. However, this fragile balance has been disrupted by Iran’s attack on Israel, with implications still unfolding. The era of “geopolitical fatigue” appears to be over, as traders reconsider their sense of security following nearly a year of stable market conditions since the Hamas attacks in Israel.

“No one really knows how far this could spread. What is the reaction now from Israel? What is the counter-reaction then from Iran? Do other players start to get involved?” Saad Rahim, chief economist at Trafigura, told Bloomberg. His concerns are not made lightly: Trafigura is a leading global commodity trader that closely follows these developments.

One thing is clear: “The crude market was extremely short and complacent about geopolitical risk,” said Bob McNally, former energy adviser to president George W. Bush. “The crude risk premium would only rise if the market saw an escalation that directly impacted energy infrastructure or flows, or if Israel attacked regime-threatening critical infrastructure.”

Despite recent events, it’s important to maintain perspective on oil price increases. After two consecutive days of gains, bringing Brent to approximately $75 per barrel— a level last seen in early September — the European benchmark remains close to its annual lows. It is not yet a significant inflationary concern amid declining interest rates in both the U.S. and Europe.

Another important factor is the shift in the global oil market structure. Countries like Saudi Arabia, the United Arab Emirates, and Kuwait possess considerable spare capacity — around eight million barrels per day — that could be tapped if needed, with four million available in the very short term (within 60 days). This buffer exceeds Iran’s daily output of 3.2 million barrels, or 4% of the total global production.

“That should ease market fears,” said León. However, China’s consumption is showing signs of weakness, and the rise of electric vehicles is putting downward pressure on medium- to long-term forecasts. The International Energy Agency (IEA) predicts a theoretical surplus starting next year, peaking in 2030.

Radical shift in market structure

The global oil market has evolved significantly over the past decade. Although still substantial, the influence of Persian Gulf countries has diminished, reducing the proportion of oil subject to geopolitical uncertainties. In contrast, production from Western nations — such as Canada, Brazil, Guyana, and especially the U.S. — has surged, with the latter becoming the world’s leading crude oil producer thanks to advancements in hydraulic fracturing, better known as fracking. This shift has led to an increased volume of crude oil that is insulated from geopolitical disturbances.

The recent price increases coincided with an OPEC meeting, where discussions on ending unilateral supply cuts starting in December are underway. If implemented, this could exert downward pressure on crude oil prices.

“If Israel’s response to Iran is measured, the markets might view it as a sign that both countries prefer to de-escalate after this brief exchange,” said Francesco Pesole, from ING bank.

“The key is Hormuz,” added León, highlighting the potential for Iran to leverage the strait to economically harm the West, which would escalate the conflict. “The implications for global supply would be monumental, comparable to the effects of Russia’s invasion of Ukraine in 2022.”

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