Volatile U.S.-Iran Relations Spark Fears Of Tumultuous Oil Prices

Historically, global oil prices have been connected to conflict in the Middle East, with open access to the Strait of Hormuz as a key determinant. The Strait is a body of water connecting the Persian Gulf with the Gulf of Oman and the Arabian Sea, serving as the only passage from the Persian Gulf to the open ocean. The Strait is approximately 34 kilometres wide at its narrowest point, making it an especially vulnerable waterway for ships. The Strait of Hormuz is one of the world’s most strategic chokepoints because according to the U.S. Energy Information Administration, major oil producers in the region ship approximately 21 million barrels per day through the waterway. This is equivalent to around 21 percent of global petroleum liquids consumption.

Understanding the importance of the Strait of Hormuz has allowed Tehran to use access to the waterway as a geopolitical weapon against hostile powers. For instance, according to Bloomberg, Iran’s Revolutionary Guard seized a U.K.-registered tanker in July 2019. This ultimately led to traffic being diverted from the Strait and oil prices increasing, as reported by CNBC. It was reported that Brent crude futures were up by 66 cents and West Texas Intermediate crude was up by 33 cents. Therefore, similar concerns for the current escalation in tensions between the U.S. and Iran are valid.

Tehran’s retaliatory strikes on U.S. forces in Iraq on 8 January 2020, which the Revolutionary Guards admitted were in retaliation for the death of General Soleimani, had an adverse effect on oil prices. According to the Wall Street Journal, major tanker operators in the region avoided crossing the Strait, as the economic fallout of the feud between the U.S. and Iran reverberated across the Middle East. While Tehran had not directly threatened tankers crossing the Strait, many operators avoided this waterway as a precautionary measure. As reported by the Wall Street Journal, this resulted in Brent crude prices increasing by more than four percent. Fortunately, relatively measured responses by Washington and Tehran following the missile strikes allowed Brent crude prices to decrease by four percent.

Oil prices have historically been a reliable measure of the intensity of conflict in the Middle East, as reported by the New York Times. While this has been true to a certain extent in the recent escalation between the U.S. and Iran, the recent boom in shale oil in the U.S. has made oil prices an increasingly broken barometer for gauging conflict in the Middle East. Oil prices did increase slightly in response to rising tensions. However, they failed to encapsulate the true extent of the conflict in the region, according to CNBC. The recent oil boom in the U.S. has made markets somewhat accustomed to a surplus of oil, rendering worries about an oil shortage obsolete according to the New York Times.

In addition, CNBC reported that experts consider a blockade in the Strait of Hormuz by Iran to be a ‘black swan’ event. A ‘black swan’ is a rare and unpredictable event, given the situation’s dire consequences. In this case, a blockade in the Strait would also hinder Iran from exporting its resources to the global market. The U.S. maintains a significant presence in the region, with the ability to outmatch any regional hostile naval force. As a result, oil prices have been relatively less volatile in the face of rising tensions in the region.

Despite experts calling a blockade in the Strait of Hormuz a ‘black swan’ event, hydrocarbon markets still respond to volatility in the Middle East. As such, the intrinsic causal relationship between conflict in the Middle East and global oil prices will largely remain intact. Volatility in oil prices is also bad for the global economy, as firms and investors prefer stability in input prices. Therefore, the relationship between Washington and Tehran will become an increasingly vital determinant for the direction of global oil prices and subsequently, the global economy.