The oil price defied analysts’ expectations and fell rather than rose after the outbreak of the Israeli-Hamas war on October 7. A month later, despite a 3.7% drop in the price of a barrel of Brent, its value has returned to pre-war levels in the last week, trading at $82 as of November 7.

Many analysts feared a repeat of the oil price spike during the Yom Kippur War 50 years ago, but it appears that oil prices no longer react to Middle East political crises in the same way, The Bell reports.

Thanks to production cuts and squeezed supplies, oil has recently been trading in the mid-90s, which has been good news for Russia and the Kingdom of Saudi Arabia (KSA), who have agreed to voluntarily cut production to bolster prices.

But the decline of the last week has erased all the modest gains oil prices made following Hamas’ invasion of Israel on October 7. At its peak on October 19, oil had reached $92.4 per barrel, still below the September maximum of $96.5 recorded on September 27, according to The Bell.

Dire warnings

After the shock of Hamas’ attack there was a flurry of alarmist warnings. The World Bank said further escalation in the Israel-Hamas violence could lead to “uncharted territory” for oil prices, potentially affecting global food prices. The Commodity Markets Outlook from the World Bank said that while the impact on oil prices should be limited if the conflict does not expand beyond the immediate clash between Israel and Gaza, the outlook would quickly worsen if the fighting escalated.

Goldman Sachs suggests that the Israel war could significantly affect economic growth and inflation in the eurozone unless energy price pressures remain contained.

Ongoing hostilities could have an impact on the already struggling European economies through reduced regional trade, tighter financial conditions, higher energy prices and decreased consumer confidence.

Business leaders are clearly already very worried about an escalation of the violence as yet another conflict breaks out on top of the Russia-Ukraine war and ballooning tensions in the South China Sea, according to Oxford Economics’ latest Global Risk Survey released on November 6. Business leaders are also concerned by the lingering economic problems and particularly sticky high inflation rates, but oddly seem indifferent to the accelerating climate crisis, which has caused floods, fires and extreme storms this year that have already done hundreds of billions of dollars of damage, and which is only likely to get worse next year.

If the fighting remains contained in Gaza then analysts anticipate oil price rises remaining very modest. But the fears are of a region-wide war that draws Iran directly into the conflict, which would have a major impact on global oil supplies and could add $86 to the price of oil, according to one estimate, sending the price of a barrel over $150 – its highest ever. Iran's crude oil production reached 2.85mn barrels per day in July, which was then only 72,000 bpd short of becoming the third-largest oil producer in OPEC. But if Iran is drawn into the war then not only would its own exports be curtailed, but Iran’s control of the Straits of Hormuz could throttle oil supplies to the rest of the world.

Not as bad as it seems, yet

Nevertheless, analysts acknowledge that the current situation differs from the 1973 oil crisis, where Saudi Arabia's oil embargo in response to the Yom Kippur War caused prices to skyrocket. Saudi Arabia and Russia have announced voluntary supply cuts until the end of 2023, which initially drove oil prices to 10-month highs in late September but have since been affected by macroeconomic concerns.

The war in the Middle East has yet to have any impact on supplies or production or the transport of oil out of the Middle East to the rest of the world.

Oil prices are currently declining because of fundamentals, especially due to a strengthening pound and indications of ongoing high interest rates in Western countries, as reported by the WSJ. In addition, recent data releases from China indicate reduced demand for Chinese exports in the West, as the global economy slows thanks to the polycrisis that is reducing demand for oil.

Hedge funds exiting long positions, initiated after the October 7 attack on Israel, also contribute to the downward pressure on oil prices, reports The Bell. During the week from October 24 to October 31, funds sold contracts equivalent to 70mn barrels, The Bell reports.

This new phase of price reductions began after the leader of Hezbollah disavowed the attacks on Israel by Hamas and pledged to avoid war with Israel. For the moment, traders are focusing on economic data from Europe and the US, downplaying the potential impact of a Middle East escalation on prices.

The focus on fundamentals rather than the conflict reflects the memory of overestimating the market impact of Russia's invasion of Ukraine in 2022, when oil prices also soared, only to fall back again, according to Helima Croft, a commodities strategist at RBC Capital Markets, as cited by The Bell.

But the experience of the Yom Kippur War in 1973 still looms large over the market. During that war Arab oil exporters imposed an oil embargo against Western countries, instantly quadrupling oil prices from $3 to $12 per barrel.

But analysts argue the likelihood of a repeat of the embargo is low and recent Middle East tensions have not had a long-term impact on oil prices.

The practical effect of the fall in oil prices will be a negative impact on Russia’s attempts to limit this year’s budget deficit to 2% of GDP. Recently oil revenues have surged, leading Russian Finance Minister Anton Siluanov to predict this year’s deficit may come in at only 1% – far better than anyone was expecting at the start of this year. That optimistic prediction is now in doubt.

Nevertheless, Kremlin's oil revenues continue to rise due to the combination of higher oil prices, even if they are not over $90 per barrel now, which is bolstered by a weak ruble as oil companies’ costs are in rubles whereas their revenue is in dollars.

Russia’s Ministry of Finance reported another surplus month in October, reducing the year-to-date deficit to RUB1.6 trillion (0.7% of GDP), compared with the planned RUB3 trillion and a deficit of over RUB3.3 trillion recorded at the start of the second quarter.