Geopolitical Risk No Longer Priced Into Oil Markets
Wells Fargo analysts noted in a note dated Monday that despite increased geopolitical tensions in the Middle East, especially in the aftermath of major violent episodes involving Hamas and Hezbollah leaders, oil prices have remained remarkably constant.
These events, which are occurring in delicate areas like Tehran and Beirut, have increased the likelihood of additional regional conflict and sparked worries about possible disruptions to the world’s oil supply, particularly through the vital Strait of Hormuz, which supplies almost 21% of the world’s daily demand for crude oil.
Oil price increases have historically been closely correlated with geopolitical developments in the Middle East as markets respond to possible risks to the supply of oil. The current circumstance, meanwhile, deviates from this trend.
Unlike in previous conflicts, oil prices do not reflect a geopolitical risk premium, as evidenced by their decline to the mid-$70s per barrel area. The protracted character of the current conflict, where early concerns of supply disruptions have given way to a more measured assessment of the actual risks involved, can be blamed for this subdued response.
According to Wells Fargo, oil markets are often extremely sensitive early in such wars, with prices responding rapidly to news and concerns about possible disruptions to supply. However, as the war deepens, the market becomes less sensitive as the risks are recognized and included into prices.
The current situation demonstrates this desensitization, since oil prices have stabilized despite the ongoing conflict, reflecting the genuine balance of global supply and demand without a substantial premium for geopolitical risk.
However, the experts cautioned investors that the dangers of supply and trade disruptions seem to be increasing.
Although the market may be underestimating the risks at this time, Wells Fargo analysts warn that any additional escalation may soon result in the restoration of a geopolitical risk premium, which could raise oil prices by $5 to $15 per barrel
