Oil prices started the week of Oct. 9 off with a surge as the war between Israel and Palestinian Islamist militant group Hamas entered its third day, but by the fourth day oil prices had settled down as traders watched for further developments in the region.
For oil prices to go meaningfully higher for longer because of the turmoil in Israel and the Gaza Strip, the conflict would have to widen regionally to major oil producers Iran and Saudi Arabia because Israel itself produces little oil.
Oil prices have broad implications for the economy and stock market because of consumer spending patterns, corporate costs and the Federal Reserve’s interest rate trajectory.
The most immediate issue is how the brutal incursion and Israeli reprisals will affect diplomatic efforts between the U.S., Israel and Saudi Arabia to improve relations between Israel and the Saudis. That deal involved a Saudi willingness to increase its oil production, depending on market conditions, in exchange for a defense pact with the U.S., the Wall Street Journal reported on Oct. 6. The war in Israel has thrown those negotiations into doubt.
“The latest developments mean that if the entire normalization discussion is canceled, so are the underlying side deals and agreements impacting oil supply and indicating continuing constraints by OPEC,” says Irina Tsukerman, president of strategic advisory Scarab Rising and the vice chair of the American Bar Association’s Oil and Gas Committee.
Meanwhile, the larger question is whether evidence will surface tying Iran directly to the Hamas attacks, which also involved a group called Palestinian Islamic Jihad. Iran backs both groups but has said it wasn’t involved in the attacks on Israel. The U.S. and Israel say they don’t have evidence linking the Islamic Republic directly to the attacks. The Wall Street Journal has reported that Iran helped plot the attack, and the Washington Post reported that Hamas got weapons and training from Iran before the assault. However, this link is still the subject of much debate as of Oct. 11.
Although Iran’s oil exports are subject to U.S. sanctions, the Islamic Republic sells the commodity to China and other nations. It has been increasing its exports as Tehran and Washington were seeking better diplomatic relations before the Hamas attack.
“Since 2022, the Biden administration has turned a blind eye to the United States’ own sanctions and has backed away from some measures meant to stop Iran’s oil shipments,” according to Brussels-based think tank Bruegel. “The easing of U.S. pressure was done to facilitate the negotiations that led to the release of five Americans imprisoned in Iran, and most notably to increase the liquidity of the global oil market in the context of the Ukraine war and sanctions on Russian oil.”
If the U.S. decides to crack down on Iranian oil exports, that would lower the amount of crude on the market, which could help boost prices if demand remains the same or increases.
Another reason why Iran is a key player is the potential for Iran to disrupt oil tankers in the Strait of Hormuz, one of the key chokepoints for seaborne shipments of the commodity. The strait is a narrow shipping corridor next to Iran that connects the Persian Gulf to the broader ocean-going oil trade. In the summer of 2019, oil prices jumped amid tensions between Iran and the U.S. involving drones in the area.
“Iran has been very belligerent around the Strait of Hormuz,” says Ed Hirs, who teaches energy economics at the University of Houston.
“If it is proven that Iran was directly involved in the attacks and/or other countries are pulled into the conflict, oil prices will probably see a prolonged increase for the remainder of the conflict,” says Tim Tarpley, president of the Energy Workforce and Technology Council.
But Hirs says he thinks the oil market’s movement higher in response to the attacks in Israel will be short-lived, with the “war premium” perhaps going away after a week, although that could change if Iran gets involved.
He points out that oil prices have stabilized amid the war between Ukraine and Russia, which involves major oil producers. So if the Israel-Hamas war remains contained, there is little likelihood for meaningfully higher oil prices.
Jamie Cox, managing partner with Harris Financial Group, agrees. “The senseless violence will have a lasting impact on the region for some time, but it won’t be in the form of higher oil prices,” he says.
An oil market commentary from GasBuddy on Monday said the early oil market reaction to the violence was “likely a knee-jerk one that may not be sustained.” The main caveat, again, was whether Iran is drawn into the conflict.
Tsukerman says the Saudis and other nations could cut oil output to pressure the U.S. into forcing Israel to deescalate with Hamas.
“For that reason, we should expect the oil prices to stay elevated, although the immediate impact of the element of surprise may moderate over time,” she says.
“It is too early to tell what the long-term effects of the conflict will have on inflation or the Fed,” Tarpley says. “It will likely depend on the severity, duration and ultimate scope of the conflict.”
Over the short term, the Fed tends to look at core inflation numbers that strip out volatile energy and food prices. But even core inflation would be affected if oil prices were sharply higher for an extended period because they trickle down into the cost of goods and services.
“As a result of energy prices likely remaining high, we can expect inflation to climb at least temporarily,” Tsukerman says. “However, whether the Fed gets involved ultimately depends on the duration of the crisis and how quickly the economy adjusts to the situation.”
On Oct. 9, the third day of the Israel war when oil prices jumped, crude producer stocks also moved higher. The Energy Sector SPDR Fund (ticker: XLE), which contains the likes of Exxon Mobil Corp. (XOM) and Chevron Corp. (CVX), gapped higher, meaning it opened much higher than the previous session’s close, leaving a gap in the fund’s price chart.
The broader S&P 500 shrugged at the Oct. 9 higher oil price and the broader energy market concern about the Israel-Hamas war, closing higher that day and the next.
But if the conflict broadens in the Middle East and oil prices move meaningfully higher for longer, the stock market is sure to view it as a negative.
Although oil companies benefit from higher prices, a prolonged rise in oil prices would be a negative for the economy and the market as a whole. Consumers spend less on goods and services when they have to use more money to buy gasoline. Costs for agricultural products rise because of farmers’ fuel needs, making food more expensive. Manufacturers have to pay more for their operations.
Some companies have more of an ability to pass those costs on to customers. Those who have to eat more of the higher costs stand to see their share price decline.
Also, the higher inflation can prompt the Federal Reserve to hike interest rates, which makes corporate borrowing more expensive.
“As for stocks, regardless of what has transpired, they needed a short-term correction, and if energy prices increase in the short term it just continues to put selling pressure on equities,” says Daniel Bustamante, managing partner and chief investment officer of asset manager Bustamante Capital. The S&P 500 is down nearly 3% over the past month as of Oct. 10. “Aside from that, geopolitical risk is going to have a larger effect on stocks, so I think many are watching closely to (monitor) the unfolding situation.”
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