MST Financial: Oil market is now underestimating geopolitical risks

According to analyst Saul Kavonic of MST Financial, the oil market is currently underestimating the geopolitical risks associated with the situation in the Middle East. He argues that oil market participants have already been inundated with a series of warnings that have not materialised. He is referring to Russian oil supplies, where Russia’s exports have proved much more resilient than Western analysts expected. The market may now, however, be underestimating the possible expansion of the conflict in the Middle East and its associated impacts.

Strait of Hormuz

We wrote here about the joint US and UK attack on Yemen’s Houthis in the first half of January this year. Iran, whose possible involvement was the biggest concern, immediately showed restraint after the attack and called on countries to maintain security in the region. Nevertheless, particularly following the US strikes on militias in Iraq and Syria, fears of Iran’s involvement persist and the likelihood of the conflict expanding is increasing.

“It is clear that security and geopolitical experts are much more concerned about the situation in the Middle East than the oil market. There are concerns that the conflict could expand, leading to greater direct involvement by Iran, which would affect the Strait of Hormuz,” Saul Kavonic said.

As a reminder, the Strait of Hormuz is a chokepoint for the global market in energy commodities such as oil or LNG (liquefied natural gas). In the case of both oil and LNG, ships carrying one-fifth of global supplies pass through it.

Will there be a price shock?

The oil market’s reaction, or rather the price impact, nevertheless fell short of expectations, to the surprise of many. Kavonic explains this by saying that, since Russia’s aggression against Ukraine, the market has become accustomed to similar news, and only an immediate threat to oil supplies will trigger a more significant move in oil prices.

“The problem is that this leaves the market much less prepared when supply disruptions actually occur,” Kavonic says.

According to Kavonic, this could theoretically cause a bigger price shock than the 1973 oil crisis. At the time, he says, only 8% of global oil supplies were affected, compared with as much as 20% in a possible scenario today. On top of this comes another gas shock linked to the growth of the LNG market in recent years. Kavonic adds, however, that while this scenario is possible, it is not likely.