Why the oil market is not shocked

ONEabout a month agoI was greeted by a welcome sight at the gas station in Connecticut where I usually fill up my tank: the price of regular had dropped to less than $3 a gallon. In the weeks that followed, however, the Middle East was plagued by an escalation of conflicts. Israel – which was already in the midst of a nearly year-long invasion of Gaza – assassinated Hezbollah leader Hassan Nasrallah with an airstrike in Beirut. Iran responded by launching a missile attack on Israel, and Hezbollah fired rocket salvos. Israel then invaded southern Lebanon, and the Biden administration appealed for restraint as the Israeli government reportedly mulled a retaliatory strike on Iran’s oil fields.

In short, the last few weeks have been as tense and belligerent in the Middle East as we have seen in many years. And yet, when I filled up my tank again yesterday, the price of a gallon of gas was just $2.94.

In the past, this would have been surprising: geopolitical turbulence, especially in the Middle East, used to send oil prices soaring, as frantic traders – anticipating potential supply shortages – added what is often called a “war premium” to the oil price. . This time, oil prices rose only slightly – at their peak in early October they were up about 10% from recent lows – and have now fallen to where they were a month ago. Prices at the pump, however, barely budged amid all the chaos. Part of this reflects the fact that a direct conflict between Israel and Iran is still more simmering than at full boil. But the oil market has also responded calmly to the clear risk of a wider war, because fundamental changes in global energy markets over the past 15 years have made the world’s economies – including, above all, that of the United States – much less vulnerable. to the turmoil in the Middle East. .

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The is the most obviousMost important of these changes is the enormous boom in oil production in the US, as the technology of “fracking” – hydraulic fracturing and horizontal drilling – has enabled the mass production of “tight oil” (so called because it is contained in impermeable shale or sandstone). U.S. tight oil production has increased about eightfold since 2010, and the country is now the world’s largest oil producer, pumping more than 13 million barrels per day – a record achieved under the Biden administration despite its commitment on paper with a shift away from fossil fuel energy.

This flood of new supply has made production from a country like Iran less important to the global oil market: Iranian exports now represent only about 2% of total global production. It also forced OPEC+, the oil cartel that includes former OPEC members, predominantly from the Middle East, as well as major producers such as Russia and Mexico, to reduce its members’ production in an effort to keep prices high. As a result, OPEC+ members have a large capacity available: estimates suggest they could produce 5 million barrels more per day than they currently produce. So even if, say, Iranian oil exports were restricted by an all-out war with Israel, OPEC+ members could easily compensate for that.

The boom in US oil production has also made it more difficult for countries like Iran to use oil as a geopolitical weapon. The conflict with Iran always raises the possibility that Tehran will try to close the Strait of Hormuz, an important waterway for oil tankers that runs between Iran and the United Arab Emirates. But because America imports less oil than before, closing the strait today would have less impact on the US than on Iran – and would hurt the main buyer of Iranian oil, China.

Additional factors also helped mute the oil market’s response to the crisis. Over time, American policymakers have become more willing to use the country’s Strategic Petroleum Reserve to soften any blows to consumers: Barack Obama used the reserve in 2011 when Libyan oil production was halted, and Joe Biden used it -a in 2022, after the invasion of Russia. from Ukraine. The strategic reserve currently holds 383 million barrels of oil, so replacing Iran’s supply would not be a challenge.

Meanwhile, economic growth, especially in China, does not necessarily translate into demand for oil as it once did. The boom in renewable energy for power generation has marginally reduced dependence on oil, as has the fact that fully electric and hybrid cars now represent almost 20 percent of the “light vehicle” (essentially, passenger car market) and probably a higher percentage of equivalent sales in China. In fact, oil traders are now concerned about weakness in China’s oil demand because Chinese growth rates have slowed dramatically in recent years.

Oil traders themselves may be less likely to be alarmed when a geopolitical crisis arises because recent history suggests that an exaggerated response – such as panic buying that drives up prices sharply – is rarely justified. In 2019, when a Houthi drone attack on oil facilities in Saudi Arabia halted half of the country’s oil production, prices soared by nearly 15%. But after the Saudis released oil from their reserves and resumed production within a matter of weeks, prices fell quickly. Similarly, in 2022, when Russia invaded Ukraine, prices rose due to fears about what Western sanctions could do to Russian oil production. But in less than two months, the cost of a barrel returned to its pre-invasion level. What traders have learned, in other words, is that betting on oil prices rising and staying due to geopolitical tension is probably a bad bet.

Franklin Foer: The war that would not end

If Israel does If you decide to bomb Iran, oil prices will almost certainly rise. But the oil market would adapt and respond to that event in a way that would minimize its impact on global prices. And because traders understand these changed market dynamics, they appear to be acting on this risk quite differently than before. It’s possible, of course, that the oil market has become overly complacent. But what seems more likely is that resilience, in a sense, breeds resilience: because traders are confident that the market will be able to handle conflict, they are more likely to assess risk calmly rather than panicked. That’s why many of us still only pay about $3 for a gallon of gas.