continue their rise today, with up by more than 3% and also trading above $80 per barrel.
The sharp rise in oil prices comes amid the rapid escalation witnessed in the Middle East in recent hours and days, proving that the hypothesis the market tends to cling to of the war’s near end is premature. The escalation disrupts global energy supplies, with a near halt in ship navigation in the Strait of Hormuz, and heightens the risk of further escalation, including targeting oil production and refining infrastructure in the region, which could make the damage structural rather than temporary.
Yesterday’s scene was hysterical and full of details as we saw widespread targeting of the Iranian mainland and islands, and targeting of American bases at several points in the region, in addition to targeting ships and oil tankers, and these events are still recurring until the time of writing. To make matters worse, we saw an unexpected and sudden return of escalation between Saudi Arabia and the Houthis in Yemen. This came with the Saudi Air Force intercepting an Iranian passenger plane that wanted to land at Sanaa airport, before warplanes bombed the airport runway and forced the Iranian plane to land at Hodeidah airport, which was followed by the Houthis targeting Abha airport in the south of the Kingdom.
With this stormy series of events, we must calmly rearrange our hypotheses. I believe we are now in a round of negotiating under fire, following the failure at the table after the signing of the recent memorandum of understanding. The major obstacle lay in reaching an understanding regarding the implementation of the fifth article of the signed memorandum of understanding, which concerns the management of the Strait of Hormuz.
While there appears to be a dispute in interpreting that fifth article, given that the memorandum was drafted and signed in a hurry due to what seems to be Donald Trump’s rush to disengage from this war and extract any concession from Iran. Meanwhile, Iran understood that article as recognition of its dominance over the strait, and consequently attacked commercial ships that were trying to cross, albeit through territorial waters, which sparked today’s escalation.
Therefore, it is not unlikely, in the midst of today’s massive wave of escalation, that we witness a sudden announcement of a return to the ceasefire, but this time through a broader exchanged understanding, backed by clearer and more precise wording regarding the management of the strait, which would leave no room for interpretation by either party as they please. I believe Donald Trump wants to end the war by any means, especially before the midterm elections, by using military pressure to try to extract concessions he could not obtain through negotiations or previous military campaigns. As for his statements about imposing a 20 percent tax on cargo ships crossing the strait, they cannot be taken seriously because they are completely unrealistic, and imposing a military blockade of the strait would also be unsustainable given the high costs and potential losses involved. If this hypothesis is correct, we might see oil prices resume their decline, erasing the gains we saw over the last two sessions, and it is also not unlikely that we will see a double-digit drop.
As for the Houthis, it is too early to talk about their entry into this full-scale regional war. I believe the recent escalation may be contained, and they may return to an unofficial peace, as I do not believe this war is in either of their interests now.
On the other hand, the bad-but-not-worst-case scenario is Trump’s inability to extract a concession from the Iranians, even through negotiations, which would mean the continuation of the current skirmishes for a long time and the establishment of a state of neither peace nor full-scale regional war. However, this would keep shipping traffic near zero in the strait, which could keep oil prices at their relatively high levels.
The worst-case scenario would be the situation spiraling out of control, involving large-scale targeting of Iranian energy facilities, which could be met with widespread targeting of its neighbors’ facilities in an effort to urge nations to pressure the US administration to stop the escalation.
If the situation develops with the Houthis bringing their full strength into this full scale war, it would also involve closing the vital Bab el Mandeb Strait, and would also involve the risks of targeting energy facilities, especially in Saudi Arabia, repeating what happened in their previous war, which peaked with the attack in September 2019 that caused the largest disruption in oil production in history, with more than 5.7 million barrels per day of Saudi production knocked offline, representing nearly half of its production at the time. However, I believe that repeating that narrative remains unlikely, at least based on current developments, though I do not rule it out completely.
Written by Samer Hasn, Senior Market Analyst at XS.com
