Further escalation of Israel-Gaza conflict could lead to higher oil prices, analysts say

A further escalation of the Israel-Gaza conflict could lead to a significant bump in oil prices in an already tight crude market, analysts have said.

Oil prices surged by as much as 5 per cent on Monday after the ruling Hamas group in the Gaza Strip launched the largest military assault on Israel in decades on Saturday.

Israel responded by launching a barrage of air strikes on the besieged Gaza Strip.

The combined death toll from the Hamas attack on southern Israel and Israel’s assault on the Gaza Strip climbed to more than 1,100 as fighting entered a third day on Monday.

Israeli Defence Minister Yoav Gallant ordered a complete blockade of the Gaza Strip on Monday. The country’s Prime Minister Benjamin Netanyahu has spoken of a “long war”.

Brent, the benchmark for two thirds of the world’s oil, has pared some gains since Monday morning and was trading 4.23 per cent higher at $88.16 a barrel at 11.08pm UAE time.

“Geopolitical risk premia tend to fade quickly if oil supplies are not impacted,” said Giovanni Staunovo, strategist at UBS. "So, market participants are likely to track Lebanon-based Hezbollah’s actions closely, as well as any escalation in Israel’s political response."

Oil traders are also likely to watch for whether the US administration would enforce stronger sanctions on Iranian crude exports, he said, adding that the risks of Tehran being dragged into the conflict had increased.

There have been reports of Iran's involvement in Hamas’s surprise attack, although the country has denied those claims. US Secretary of State Antony Blinken has also said there is no evidence linking Tehran to the attack.

Iran's production has recovered to a five-year high of 3.1 million barrels per day in recent months, despite current sanctions.

"At present, there is no immediate threat to the oil supply but the market is understandably apprehensive," said Ole Hansen, head of commodity strategy at Saxo Bank.

"Often, market sentiment and concerns can exert greater influence than the actual underlying fundamentals."

The International Energy Agency expects the oil market to record a substantial deficit in the fourth quarter of the year, mainly due to Opec supply cuts.

Last week, Saudi Arabia and Russia reaffirmed their collective supply cut of 1.3 million bpd until the end of the year.

Goldman Sachs has maintained its oil price forecast of $100 a barrel by June 2024 and says it expects Saudi Arabia to unwind its voluntary output cut of 1 million bpd “gradually” by the first quarter of 2025.

UBS expects Brent crude to move back into the $90-$100 a barrel range in an undersupplied market.

If fears of wider geopolitical conflict are allayed, markets may revert to demand-side concerns, which have weighed heavily on oil prices so far this month, Han Tan, chief market analyst at Exinity, told The National.

Last week, oil prices posted their biggest weekly loss since March amid demand concerns.

Brent dropped about 11 per cent while WTI posted a more than 8 per cent decline, on market worries that persistently high interest rates would slow down global economic growth.

“Global equities may show a larger reaction if the ongoing conflict threatens to further darken the global economic outlook, while forcing major central banks to veer off their 'higher-for-longer' course,” Mr Tan said.

Recently, US Federal Reserve chairman Jerome Powell warned it would be prepared to raise rates if data warranted it, even though the central bank appears to be near or at the end of its rate increase cycle.

He has also said rates will be held at a restrictive level until the Fed is convinced inflation is moving down sustainably.

Market impact

The Bank of Israel on Monday said it would carry out a sale of up to $30 billion in foreign exchange to support its currency after the shekel dropped to a near eight-year low against the US dollar in early trading on Monday.

The central bank “will operate in the market during the coming period in order to moderate volatility in the shekel exchange rate and to provide the necessary liquidity for the continued proper functioning of the markets”, the regulator said in a statement.

The move will provide additional liquidity of up to $15 billion to the market.

Meanwhile, Israel's Tel Aviv share index, the TA-35, was up by 0.38 per cent at 2.50pm UAE time after it closed about 7 per cent lower on Sunday, marking the market’s sharpest fall in more than three years.

In other parts of the region, Saudi Arabia’s Tadawul and Abu Dhabi Securities Exchange, the region’s two biggest stock markets, were down 0.29 per cent and 1.29 per cent, respectively, while Dubai Financial Market closed down 2.6 per cent.

“Financial markets seem to be shifting into partial risk-off mode … safe-haven government bonds could see a pause in rate increases amidst the return in safe-haven flows,” said Norbert Rucker, head of economics and next generation research at Julius Baer.

“The key question is how lasting these safe-haven flows are if this weekend has brought some tectonic shifts in the geopolitical landscape.”

The Israel-Gaza war has "the potential to expand to a prolonged conflict" that historically has been a headwind for global equity markets, said Norman Villamin, group chief strategist at Union Bancaire Privée.

"A look back at the impact of such geopolitical conflicts – ranging from coups/assassinations, to terrorist events, and including cross border wars between nation-states – on the S&P 500 going back to 1940, in aggregate suggest modest upfront impact," he said.

"However, the type and duration of the event is significant in understanding the potential impact upon markets ... Thus, the risk that this recent development transforms from a localised event to one that is prolonged and engulfs a wider range of nations should be among the key concerns for investors."

Economic outlook

Growth in the Mena economies is expected to slow sharply this year, as the regional oil exporters continue to cap crude production amid stiff global economic headwinds, the World Bank says.

Aggregate economic growth in Mena is expected to drop to 1.9 per cent in 2023, down sharply from the 6 per cent gross domestic product expansion recorded last year, the Washington-based lender said in its Mena Economic Update last week.

The latest conflict is also likely to have a major effect on the Palestinian economy, which has already been facing headwinds.

The Palestinian economy is expected to continue operating well below its potential and growth is projected to hover around 3 per cent, a World Bank report last month found.

Given population growth trends, income per capita is also expected to stagnate, damaging living standards, the lender said.

In addition, a combination of fiscal constraints and the restrictions imposed by Israel hinder access to health care, adversely affecting the population, especially in Gaza.

“Over the last five years, the Palestinian economy has basically been stagnating and is not expected to improve unless policies on the ground change,” said Stefan Emblad, World Bank country director for the West Bank and Gaza.

“The Palestinian territories have been in a de facto customs union with Israel for 30 years but contrary to what was expected when the agreements were signed, the divergence between both economies has continued to widen, with income per capita in Israel almost 14 to 15 times higher than in the Palestinian territories."

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