Middle East War Risk Soars to 50% as Tensions Escalate

Middle East War Risk Soars to 50% as Tensions Escalate

Analysts warn of potential regional conflict and its impact on global oil markets.

Geopolitical risks in the Middle East have reached their highest point since the start of the Israel-Hamas conflict last October, according to BMI, a unit of Fitch Solutions. In a report released on Monday, BMI analysts stated that they now assess the probability of a regional war at 50%.

The report highlights the potential consequences of such a conflict, particularly on global oil supply. "This could impact regional oil supply in various ways, such as via tighter sanctions enforcement on Iran, attacks on oil and gas infrastructure, and disruptions to trade," the analysts warn.

The Middle East and North Africa (MENA) region is the dominant oil exporting area globally, and home to three crucial maritime chokepoints - the Strait of Hormuz, the Bab el-Mandeb Strait, and the Suez Canal. These waterways carry over a third of global seaborne oil flows, making them highly vulnerable to disruptions.

The analysts find it surprising that the oil market has reacted so mildly to the escalation of tensions between Israel and Hezbollah. While geopolitical events in the MENA region have historically led to significant price rallies in Brent crude, the current situation has not triggered a similar response.

"Iran, Hezbollah, and other allies in the 'Axis of Resistance' are widely expected to retaliate for the recent attacks, but the timing and nature of this retaliation are unknown," the report states. This uncertainty is reflected in the Israeli shekel and Iranian rial, but not in oil prices, leading analysts to believe that the market is currently undervaluing the risk.

The analysts attribute this muted response to several factors, including weak sentiment in the oil market, building short positions, and a greater focus on demand-side developments over supply-side concerns. However, they caution that oil markets are prone to sudden shifts in sentiment and that investors may be caught off guard if tensions escalate further.

The report outlines three potential scenarios for the conflict's development, each with distinct implications for Brent crude prices:

Scenario 1: Small Israeli Response, Followed by De-escalation (50% probability): Under this scenario, Brent crude is likely to pare back recent losses but remain within a trading range of $75-$85 per barrel.

Scenario 2: Larger Israeli Response, But Only in Lebanon (45% probability): This scenario could lead to a short-term rally in Brent, but the lack of direct threat to oil infrastructure is expected to limit gains to $5-$10 per barrel. Prices are likely to return to the $75-$85 range in the long run.

Scenario 3: Large Israeli Response, Both in Lebanon and Iran (5% probability): This scenario poses the most significant risk to oil supply and could drive Brent crude prices above $100 per barrel, potentially exceeding $150 if Iran blocks the Strait of Hormuz.

Despite the escalating tensions, BMI maintains its current forecast for Brent crude to average $85 per barrel in 2024 and $82 per barrel in 2025. However, they acknowledge substantial downside risks and plan to revise their outlook at the end of the month based on the evolving situation.

The report highlights a divergence in market sentiment between analysts at BMI and those at Saxo Group. While BMI maintains a neutral outlook, Saxo’s Head of Commodity Strategy, Ole S. Hansen, believes that Brent crude is likely to remain within its current support levels, with limited upside potential beyond the mid-80s. He cites concerns over Chinese demand, potential US recession, and a recent deleveraging move in global markets as factors influencing this perspective.

Despite the uncertainty surrounding the situation, the report serves as a stark reminder of the potential impact of regional conflicts on global oil markets. The coming weeks will be crucial in determining the trajectory of the conflict and its implications for energy prices.

Read more