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How Middle East conflicts have affected oil markets in the past

By Connor Freitas

How will the oil prices react to America’s assassination of Major General Qassem Soleimani? Here’s how the markets reacted to major Middle East events in the past

The new decade had barely begun when relations between America and Iran plunged to perilous lows. On 3 January, a US airstrike killed top Iranian military commander Qassem Soleimani near Baghdad airport. The assassination took the world by surprise – including Tehran, which vowed to take “crushing revenge”.

Unsurprisingly, oil prices increased substantially as the markets came to terms with the ramifications of Major General Soleimani’s death. The cost of a barrel of Brent crude has risen by 4.54 per cent at the time of writing – flirting just below the $70 mark. It’s likely this increase is borne out of fears that Iran may choose to retaliate by attacking oil processing facilities – potentially in neighbouring Iraq, one of the world’s biggest producers. There are also concerns that Tehran will target tankers in the Strait of Hormuz, a crucial but narrow passage where a fifth of the world’s supply travels through.

Assessing immediate reaction on the stock markets can offer a barometer as to where the main risks lie. Shares in oil giants such as Shell and BP actually rose following the attack because of the sudden jump in crude prices. Meanwhile, fuel-reliant companies such as airlines saw their stock fall on exchanges worldwide – American Airlines was down 5 per cent on Friday, Air France-KLM shed 8 per cent, Lufthansa fell 6.5 per cent, and the likes of Ryanair and easyJet also suffered a decline.

The question now is what will happen to oil prices in the coming weeks and months. A lot of this depends on how – and when – Iran strikes back. Any retaliation against Americans or US assets would undoubtedly drive prices higher and potentially cause the crisis to escalate further, as Donald Trump has warned his administration might respond disproportionately. However, many analysts expect that oil prices will begin to revert back to previous levels if a Tehran-led attack on infrastructure doesn’t happen in the short term.

Here, we’ll take a look at how oil prices have responded to major events in the Middle East previously – and explain why this incident could be different.

The Gulf War

This conflict began on 2 August 1990, when Iraq invaded the small but oil-rich nation of Kuwait. Saddam Hussein’s apparent motivation was to gain control of these reserves. The spot price for crude quickly soared by about a third to reach $28. One of the biggest factors in the subsequent rise to $40 a barrel lay in how the United Nations prohibited countries from importing oil from Iraq and Kuwait alike – and at the time, this was equivalent to reducing the world’s output by approximately 7 per cent.

With Hussein formally declaring that he was annexing Kuwait, world leaders were fearful that Iraq may try to threaten Saudi Arabia next – a move that would mean it controlled close to 50 per cent of known oil reserves at the time. Operation Desert Shield saw a coalition of nations join forces to protect Saudi Arabia, the world’s biggest producer and exporter of oil, from any Iraqi-led attack. Even though the conflict continued until April 1991, when a ceasefire agreement was reached, oil prices returned to pre-war levels of $20 by January of that year – partially because of how other countries ramped up production to compensate for the shortfall caused by the trade embargo on Iraq and Kuwait.

The 2003 Iraq War

Analysts such as Robert Looney of the Naval Postgraduate School say the oil markets followed three phases in the six months running up to the 2003 Iraq War, as it became increasingly clear that the US was planning to invade. While the first phase from October to November 2002 saw prices fall to lows of about $25, given how OPEC production had recently reached 12-month highs, a “war premium” soon emerged – with prices reaching highs of almost $38 in mid-March amid fears that a conflict would damage oil infrastructure across the Gulf region. The war began a week later, but many traders were optimistic that the clashes would be short-lived and inflict little damage on oilfields.

Indeed, in the first couple of months, prices did fall – with OPEC members resolving to compensate for the lack of Iraqi exports by utilising excess production capacities. Prices tumbled to about $23 in late April of 2003 and finished the year at approximately $30. In 2004, OPEC admitted that oil prices reached “unanticipated high levels” because of a multitude of factors – including a sudden surge in demand, distribution bottlenecks and heightened geopolitical tensions. A high watermark of $46.61 a barrel was reached in October of that year – a 58 per cent increase from the start of the year.

Saudi drone strike

In 2019, prices were muted until half of Saudi Arabia’s oil capacity was affected by damage to infrastructure caused by coordinated drone attacks. It was described as an “unprecedented attack on the world’s energy supply”, with the US holding Iran responsible. Six million barrels of output per day were affected, which equates to approximately 5 per cent of the world’s supply. Brent crude did balloon to $72 per barrel in the immediate aftermath of the attacks amid concerns about supply security, but within 10 days, prices quickly subsided as Saudi production speedily returned online.

What lies ahead?

Although looking to the past can be useful, historical turbulence may not accurately reflect how the oil markets will react following Major General Soleimani’s assassination.

Times have changed in the industry. Oil production in the US has risen by about 7.5 million barrels a day over the past decade, meaning America is nowhere near as reliant on imports as it once was. This could help mitigate supply issues – especially as the States recently achieved a major milestone when it became a net exporter of oil for the first time in 75 years. That said, other factors could cause concern, not least because OPEC members are planning to reduce their output later in January – a supply squeeze that could inflate prices.

Some analysts believe that the so-called “risk premium” attracted by the US-Iran crisis will be short-lived, pointing to the oil market’s recovery following on from the Saudi attack. But given how Major General Soleimani’s death is a significant escalation, the world is beginning 2020 with fresh uncertainty – adding to the headaches of a slowdown in global growth and simmering trade tensions between the US and China.

FURTHER READING: Oil may struggle to repeat 2019's performance in 2020

FURTHER READING: US and Iran allies try to diffuse tensions after US airstrike

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