Why Brent isn’t reacting to escalating geopolitical risk

Today’s geopolitical temperature is close to boiling point. In response to flare-ups across the Middle East feeding off the war in Gaza, the US has led strikes on specific targets across the region. The key shipping lanes of the Red Sea – through which about 6 million b/d, or 15% of the world’s traded crude oil, as well as 3 million b/d of refined products pass – have already been disrupted. So why haven’t oil prices leapt in response, as we’ve seen in the past? I asked VP Ann-Louise Hittle for her thoughts.

Why haven’t crude prices spiked?

While there is a serious threat of disruption, fundamentally the supply of oil has not been affected. The war has edged closer to large oil producers in the Gulf region – Iraq, Saudi Arabia, UAE and Kuwait – but their output remains unaffected. The transport of oil has been disrupted by the attacks in the Red Sea, but traders and shippers have been able to adjust the flows of crude and product cargoes. More tankers are being routed around the Cape of Good Hope, taking longer to reach their destination.

As yet, there’s been little or no effect on supply to the global crude oil market. However, because Europe relies on imports of jet and diesel from the Middle East and India, higher freight rates and longer journey times have pushed up Atlantic Basin refining margins.

Is there spare crude capacity in the event of disruption?

Yes, OPEC spare productive capacity is at a high level. We think the three big Middle East producers – Saudi Arabia, UAE and Kuwait – have a combined and readily available spare capacity of 4.8 million b/d, including crude recently held back from the market to balance supply and demand. That’s almost double that of a year ago.

Why has OPEC+ taken so much oil off the market?

Two reasons – persistent non-OPEC oil supply growth and uncertainty about global demand through the economic downturn. Non-OPEC production continues to increase, albeit more slowly, taking market share from OPEC+. After growing 2.1 million b/d in 2023, non-OPEC supply increases by 0.8 million b/d in 2024 in our forecast, with the US growing at a slower rate. More efficient use of capital continues to compensate for lower levels of spend in non-OPEC countries, as we have argued.

Oil demand has bounced back from the pandemic to new record levels in 2023. We expect another sizeable increase of 2.0 million b/d this year, opening the door for OPEC+ to put more of its crude back into the market. However, that’s at the high end of the range of forecasts. With the global economy still sluggish, a sense of downside risk to demand growth has pervaded in the early weeks of 2024.

What does it all mean for prices?

Oil prices are being driven more by fundamentals than by the heightened geopolitical risk. Brent has largely continued to trade in the US$75 to US$81/bbl range, reflecting both ample supply and weak sentiment on demand growth – and despite the rising tension and missile attacks in the Middle East. We forecast prices will begin to rise in Q2 2024 as the fundamentals strengthen. If they don’t, we expect OPEC+ to hold the line on its strategy to keep the market balanced and support price. Either way, OPEC spare capacity will stay at high levels, which means price reactions to provocations in the region will remain dampened as long as production is not affected.

What’s the biggest risk to price?

A significant escalation of tension and military activity. Much depends on where a missile hits – if oil production, processing or transportation infrastructure of scale in the region were to be taken out, the oil market would react as the stakes ramp up. So far, Iran has been trying to avoid escalating the regional turmoil into a war with the US or Israel. Similarly, the US is carefully calibrating its attacks, but it is a high-risk situation. Arab producers in the Gulf are carefully keeping a distance from the Israel-Hamas war.

Why has Saudi Aramco abandoned its capacity expansion?

One reason could be there is no pressing need to lift capacity from the current 12 million b/d to the previous target of 13 million b/d. Current production is averaging about 9.1 million b/d and there’s sufficient spare capacity in the system for the time being. Given the market dynamics, it’s astute timing to abandon the 13 million b/d target.

I’d add that with non-OPEC production still ticking up and peak oil demand in 2030 in our forecasts, capital discipline rather than investment in additional capacity is a prudent choice for Saudi Aramco.

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