Oil price spikes on Gulf attacks

It has been a volatile 24 hours for the oil market with prices spiking 4% after a Norwegian and a Japanese oil tanker were attacked in the Strait of Hormuz, the bottleneck of Middle Eastern waterborne oil exports. The worsening geopolitical situation would have been sufficient to prompt a sharp move higher on a regular day but the rally this morning was even more pronounced because prices slipped below $60 late Wednesday when US data showed an unseasonal increase in domestic reserves caused by lower demand.

The tensions between the US and Iran have been rising over sanctions imposed on Iran and although Iran has neither confirmed nor denied its involvement in the attacks the situation in the Gulf remains unstable, clearing the way for further flares in the oil price.

The Hormuz Strait is the narrowest point in the Gulf with only 21 miles of sea separating the coast of Oman from Iran. Tensions in the Gulf have been brewing for weeks with similar incidents happening only a few weeks ago. But because this is a choke point for oil exports from the Middle East the US navy is positioned on either side of the Strait and is likely to step in swiftly if the passage needed to be kept clear. There is clearly scope for more short-term flare ups but it is unlikely that the situation would be allowed to escalate for a serious length of time.

Bigger supply/demand picture

Looking beyond the 4% spike this morning, over the long term the oil price is likely to remain wedged in between two large factors defining both the downside and the upside.

Saudi Arabia, OPEC and Russia are all keen to prevent oil prices from sliding back to the lows of around $50 seen in December. On the sidelines of the recent G20 meeting Saudi Arabia and Russia discussed whether to keep the current production cuts in place which were agreed when oil prices last dropped in December. Several comments indicated that the two major oil producers had already agreed in principle to continue to keep the production restrictions in place but they stopped short of making a formal statement, likely leaving it until the full formal OPEC meeting later in June.

In addition to the OPEC and Russia cuts, US sanctions on Venezuela and Iran and problems earlier this year with tainted Russian exports have already tightened available supplies in the market.

This week’s US oil stock data shows that the US market is in a different position to the rest of the world, heading in the direction of being oversupplied because of ample domestic production and unusually low demand for this time of year.

At the other end of the scale the continued trade friction between China and the US is keeping the growth of Chinese demand in check while economic growth in the rest of the world this year is not strong enough to merit more than a small increase in demand.

These two factors have kept the oil market in a range between $50 and $85 in the last six months and will continue to do so in the medium term. In the short term however, Gulf safety will remain the dominant factor.