A further escalation in Iranian-Israeli tensions could take oil prices above $80 and would mean more upside for the dollar. This is the view of economists at ING, which published a research note on Friday afternoon (13 June).
Israel has launched coordinated strikes on Iran’s primary nuclear and ballistic missile facilities, as well as targeting senior IRGC commanders and nuclear scientists. In response, Iran has retaliated with approximately 100 drones aimed at Israeli territory and marking a major escalation in regional hostilities. Israel has declared a state of emergency, framing the strikes as pre-emptive and warning of further operations.
With further Israeli strikes likely, Iran’s drone attack is unlikely to be Tehran’s final response. ING said Tehran must weigh the need to reassert deterrence, taking into account a depleted proxy network, against the risk of provoking a broader war and direct US involvement.
While past behaviour suggests Iran may ultimately de-escalate to preserve regime stability, the situation remains highly volatile.
How could it impact the oil price?
“Any escalation that leads to a disruption in Iranian oil flows will be more supportive for prices. Iran produces roughly 3.3m b/d of crude oil and exports in the region of 1.7m b/d. The loss of this export supply would wipe out the surplus that was expected in the fourth quarter of this year and push prices towards $80/bbl. However, we believe prices would finally settle in a US$75-80/bbl range,” ING said.
“OPEC sits on 5m b/d of spare production capacity and so any supply disruptions could prompt OPEC to bring this supply back onto the market quicker than expected.”
A more severe scenario is if escalation leads to a disruption in shipping through the Strait of Hormuz. This could impact oil flows from the Persian Gulf. Almost a third of global seaborne oil trade moves through this chokepoint, the group said.
“A significant disruption to these flows would be enough to push prices to $120/bbl. OPEC’s spare capacity would not help the market in this case, given that most of it sits in the Persian Gulf.
“Under this scenario, we would need to see governments tap into their strategic petroleum reserves, although this would only be a temporary fix. Therefore, significantly higher prices are needed to ensure demand destruction.”
What will it mean for the UK?
The FTSE 100 reacted strongly to the strikes overnight but has since recovered and is currently 0.3% down on the day. Notably, energy companies BP and Shell are benefiting from a spike in oil prices following the attack.
Higher fuel prices will have knock-on cost effects across most sectors in the UK. As such, the conflict will be watched closely by central banks, including the Bank of England.
“Ten years ago, central banks, including the Federal Reserve, would have viewed an oil price spike as a dovish factor for interest rates. Weaker growth typically outweighed concerns about a short-lived spike in inflation. But that thinking has changed considerably since the Covid pandemic,” ING said.
“In Europe, the 2022 natural gas and oil price spike fed a long-lasting pick-up in service-sector inflation. Officials at both the Federal Reserve and the Bank of England have warned about a similar feedback loop emerging today.”
The Bank for International Settlements has also warned central banks that it will be harder to simply look through supply shocks.
“Those fears may be overblown. Through both the pandemic and the 2022 energy price shock, the broader economic environment was ripe for inflation to take off. In both cases, governments offered substantial fiscal support to offset the impact, a task made much harder today by higher interest rates and jittery financial markets,” ING said.
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