Geopolitical tensions and the rising oil risk premium threaten global recovery

REAL ECONOMY BLOG | April 15, 2024

Authored by RSM US LLP

Global oil markets are pricing in a risk premium of $7 to $10 a barrel in the wake of Iran’s drone attacks on Israel over the weekend, posing the single largest risk to the current global economic recovery.

Despite in the rise in the risk premium, reflected in futures markets, early trading in oil was muted on Monday. The Brent crude benchmark fell slightly to $89.87, and the West Texas Intermediate benchmark also edged down, to $85.87 per barrel.

Traders seemed to take the view that Iran’s response to Israeli strikes on Iran’s consulate in Syria was an isolated event. Saturday’s attack by Iran was well telegraphed and limited in duration.

Still, the attack was part of a larger proxy war between Israel and Iran that underscores the large risk premium that drives global oil and energy prices. In the near term, the rising risk premium, combined with a stronger dollar, are placing a modest drag on overall global economic activity.

But for the conflict to have a larger, material impact on global growth, the benchmarks will need to reach $115 to $135 a barrel.

Commodity price uncertainties

It is critical that the conflict not escalate further, particularly given Iran’s significance in global energy markets. Iran ranks as the world’s seventh-largest producer of crude oil, with about 4% of global production, and the third-largest producer of natural gas, with about 6% of global output.

But the threat to economic stability lies not only in Iran’s oil exports, but also in its influence over critical shipping lanes. Nearly 10 billion cubic feet of liquified natural gas travels through the Strait of Hormuz each day, a crucial link to global economic activity that is partly controlled by Iran.

Despite rising risks, as long as Israel does not attack Iranian oil production facilities or disrupt the transmission of critical energy supplies, oil markets will most likely remain well behaved.

U.S. market insulation

As the largest producer of oil and gas, the United States responds differently to world events than other global economies. The United States produces 13.1 million barrels of oil per day. Crude oil is more easily exported than natural gas, so as a result, prices tend to be more responsive to world events.

U.S. natural gas prices, by contrast, tend to be somewhat insulated. But as American capacity to export liquefied natural gas expands over time, the price sensitivity to global events will increase.

Domestic political implications

The potential political ramifications in the U.S. extend beyond the immediate conflict. If crude oil prices remain elevated, we can expect higher gasoline prices at the pump—the average price per gallon of regular unleaded gasoline stands at $3.63. And with prices expected to exceed $4 a gallon this summer, gasoline prices will continue to be a sensitive issue during an election year.

The takeaway

Companies with direct exposure to energy markets should closely monitor geopolitical developments, but once again we do not see an impending oil crisis so long as the conflict does not escalate.

With a forecasted shortfall in oil supplies this year, though, and the conflict expected to continue, executives and investors should anticipate that global oil prices will remain higher for longer.

If oil prices do remain higher for longer, it is all but certain to renew an interest in energy efficiency or alternative fuels, creating additional opportunity amid the conflict.

This article was written by Joseph Brusuelas, David Carter and originally appeared on 2024-04-15. Reprinted with permission from RSM US LLP.
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