The Yom Kippur War of 1973 saw a quadrupling of oil prices and a global energy crisis: will this happen again? 

Israel invaded Lebanon and Iran attacked Israel. The conflagration in the region seems to be spreading and the combatants seem to be in this for the long haul.  

Oil prices rallied strongly this week immediately after the attack on Israel. Brent has rallied around 8% and is on course for its best week since late 2023. The rally was initially faded as it was in April but the latest leg higher seemed to come as President Biden indicated the US was looking at the possibility of Israeli strikes on Iran’s oil infrastructure. But the upside seems to be limited versus what we might have expected. What’s going on? 

We looked at commodities including oil in this week’s podcast. (caveat emptor: this was recorded before the Iranian attack on Israel). 

Short  

One reason why the market has yet to really move aggressively higher is positioning. The futures market is incredibly short oil. Hedge funds have never been so pessimistic about crude. You have a lot of negativity in the market because of expectations for a major supply glut next year. The China stimulus package is seen missing its mark in terms of delivering a major economic boost and there are big concerns about demand in Europe faltering.  

So, a lot of the rally may be short-covering on near-term risk assessment, rather than a fundamental re-appreciation of the oil market. But if it goes it could go very quickly because of this crowded short trade. 

Indeed, the backwardation in the curve suggests real concerns about the demand profile. Spot prices are strong on the Middle East fears but the supply glut expected next year is keeping the back end well down. With OPEC+ raising output there is pressure on inventories even if right now they are tight. 

Glut 

Market participants expect OPEC and non-OPEC allies to boost oil production later in the year. Non-OPEC+ oil production, particularly from Brazil, Guyana, Canada, and the US, is expected to rise by 1m bpd in 2024 and a further 1.6m bpd day in 2025, notes BofA. 

The OPEC+ joint ministerial monitoring committee meeting (JMMC) concluded on Wednesday, with the ministers maintaining the plan to start raising output in December. Total OPEC+ output cuts currently represent 5.86 million bpd. In December, members will increase output by 180,000 bpd as they begin to unwind. Cuts. 

The Saudis don’t want to lose any more market share. In addition to its share of the OPEC+ cuts, Saudi Arabia has voluntarily kept an extra 1m bpd off the market. , Saudi Energy Minister Prince Abdulaziz bin Salman warned that if some members insisted on continually violating their quota agreements, oil prices could fall to $50 per barrel. 

Iran? 

Iran accounts for about 1.7m bpd in supply…OPEC+ has lots more than this in spare capacity. What has really spooked the market first, vaguely, is the idea of a general war and second, specifically, closure of the Strait of Hormuz, through which about one-fifth of global oil supply passes. Goldman Sachs says a sustained 1 million barrels per day drop in Iranian production would see a peak boost to oil prices next year of around $20 per barrel. 

Libya 

Yesterday, Libya said it would resume full oil production, which ought to return about 700k bpd of oil to the market, replacing lost barrels from Iran and others in the Gulf region who could be affected by the conflict or shipping blockages. Libya produces around 1.2m bpd but this had declined to around 450k bpd amid a dispute among rival political factions in the country. 

Macro 

Is the macro outlook more bullish for oil than the backwardated curve indicates? China’s fiscal and monetary stimulus certainly seem to be providing relief to their stock markets, and helped lift some industrial commodities. But it’s unclear whether it’s enough. The Fed is cutting rates at a rate of 100bps in two months whilst the economy is still motoring along. Certainly the US economy is a lot less sensitive to Middle East oil shocks than it was in the 1970s. This will insulate the US consumer a lot. Europe may be more sensitive, as would China. The rally in the USD to a 6-week high (again not a major move historically) makes sense in this context as well as from its broad safe haven appeal. 

China 

Chinese demand remains weak and seems to be getting worse. the IEA said recently that the main driver of the sluggish growth in global oil demand this year has been “a rapidly slowing China,” where oil consumption contracted on an annual basis for a fourth straight month in July by 280,000 bpd.  

China’s oil demand is now set to expand by only 180,000 bpd this year, “as the broad-based economic slowdown and an accelerating substitution away from oil in favour of alternative fuels weigh on consumption”, the IEA said. 

In August, data shows refiners in China processed around 12.6m bpd of crude oil, down 10% from July and 17.5% lower year-on-year, which would indicate oil demand fell below 12.5m bpd. This implies demand -15% YoY to its weakest level since August 2022 and inventories +3.2m bpd in August, the fastest build since 2015. 

1973? 

Oil has had its biggest weekly move in a year but not blown the lights out: OPEC members sitting on around 5m bpd of spare capacity and worries about China demand keep the shorts happy. 

And even if things get a lot worse from here, I doubt we see anything like a repeat of the 1973 scenario. Think more 1990 Gulf War, or Russia invading Ukraine. 

The supply profile is radically different for starters with the US pumping out record amounts of crude. The world has changed a lot since then – energy intensity of GDP is far lower than it used to be, and we are a lot less sensitive to the oil price as a result. Oil remains sensitive to geopolitics, clearly, but the global economy may be a lot less sensitive to oil prices.  

Neil Wilson

Chief Market Analyst at Finalto

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