Oil markets have been on a wild ride this week since the escalation and de-escalation of the conflict in the Middle East between Israel, Iran and ultimately the US. The 12-day war saw Brent crude prices surge higher initially, which then topped out near $80 after the US got involved. But prices plunged dramatically after the symbolic Iran retaliation and US President Trump’s announcement of a ceasefire between all sides.
The key risk to markets has been how Iran would respond to the Israeli attacks. Iran, the third biggest OPEC producer (despite US sanctions), pumps around 3.3 million barrels a day of crude oil and exports roughly 1.7 million barrels a day. The loss of this export supply would wipe out the surplus that was expected in the fourth quarter of this year. However, OPEC+ sits on 5m b/d of spare production capacity, and so any supply disruptions could prompt the group to bring this supply back onto the market quicker than expected.
The importance of the Strait of Hormuz
There has been much speculation about Iran potentially closing the Strait of Hormuz. This is a crucial choke point for global oil and LNG flows, with a quarter of all seaborne oil trade moving through the strait, and more than 80% of this going to China, India and the rest of Asia. In addition, roughly 20% of global LNG trade moves through this 33km-wide channel in the Persian Gulf.
Such a decision would have to be approved by the Iranian Supreme National Security Council and is long regarded as Iran’s “nuclear option” for the global economy. Any move to close the Strait could also be undermined by the US carrier presence in the region, with the likelihood that the US response would be swift and severe. Importantly it would hurt China among many other countries, while Iranian food imports also come through the Strait.
Market positioning
As soon as it became clear that closing the Strait was off the table, the risk premium in oil prices evaporated. The move was accelerated by futures positioning as producers had bought ‘put’ options after the sharp rise on the first Israeli attacks, which pay out if crude falls.
Dealers manage these positions by purchasing futures so as the price of Brent did drop, the probability rose that dealers would have to pay out. That necessitated selling more and more futures which caused the biggest one-day decline in crude prices in nearly three years.
What to look out for
Price jumps triggered by geopolitical drama often fade quickly unless it is an event on the scale of the Russia-Ukraine conflict where markets have to reorient trade flows over a prolonged period. Any major escalation or breakdown in the current ceasefire could prompt a knee-jerk bid in oil prices. But the focus remains on the Strait of Hormuz and so far, oil flows have continued with Iran exports actually surging,
Of course, while concerns regarding Middle Eastern supply have diminished for now, they have not entirely disappeared, and there remains a stronger demand for immediate supply. President Trump also recently expressed his desire to maintain the flow of oil from Iran, hoping that China can continue to buy Iranian crude. That said, curbs do remain so this will need to be watched closely going forward.
The dollar has been guided by oil markets in recent days, but this correlation should lessen going forward, with a focus for USD on trade, macro and the Fed going forward. Risk markets have also looked through the geopolitical news, with US stocks posting or about to hit new record highs.
On the charts, prices didn’t get as far as the year-to-date January top at $81.80 in the spike higher and plunged through the 200-day simple moving average (SMA) at $71.66. The swing low from September 2024 is at $68.50 with the midpoint of this year’s sell-off at $70.02. Initial support has come from the 50-day SMA at $66.09 and the next major Fibonacci level (38.2%) of the 2025 decline at $67.24. The minor retracement level below here (23.6%) is $63.80.