Why the oil market isn’t shocked

Aabout a month agoI was greeted by a welcome sight at the Connecticut gas station where I usually fill my tank: the price of regular had dropped below $3 a gallon. In the weeks that followed, however, the Middle East was plagued by escalating conflicts. Israel – already in the midst of a nearly year-long invasion of Gaza – assassinated Hezbollah leader Hassan Nasrallah with an airstrike in Beirut. Iran responded by launching a rocket attack on Israel, and Hezbollah fired volleys of rockets. Israel then invaded southern Lebanon, and the Biden administration urged restraint as the Israeli government reportedly considered a retaliatory strike on Iran’s oil fields.

In short, the past few weeks in the Middle East have been as tense and combative as we have seen in many years. And yet, when I refilled my tank yesterday, the price of a gallon of gas was only $2.94.

Once upon a time this would have been surprising: geopolitical unrest, especially in the Middle East, caused oil prices to soar, while frenzied traders – anticipating possible supply shortages – added a so-called ‘war premium’ to the price of crude . . This time, oil prices have risen only slightly (at their peak in early October, they were up about 10 percent from recent lows) and have now fallen back to around the level of a month ago. In the meantime, prices at the pump barely survived all the chaos. Some of this reflects the fact that direct conflict between Israel and Iran is still more likely to be simmering than simmering. But the oil market has also reacted calmly to the clear risk of broader war, as fundamental changes in global energy markets over the past fifteen years have made the world’s economies – including especially that of the United States – far less vulnerable to tumult in the Middle East. .

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The is the most obviousKey among these changes is the oil production boom in the US, as the technology of ‘fracking’ – hydraulic fracturing and horizontal drilling – is mass producing ‘tight oil’ (so called because it is contained in impermeable shale or sandstone). U.S. tight oil production has increased roughly eightfold since 2010, and the country is now the world’s largest oil producer, producing more than 13 million barrels per day — a record reached under the Biden administration, despite the paper’s committed commitment to a shift. away from energy from fossil fuels.

That flood of new supply has made the production of a country like Iran less important to the world oil market: Iranian exports now amount to only about 2 percent of total global production. It has also forced OPEC+, the oil cartel that includes OPEC’s longtime, mainly Middle Eastern members, as well as major producers like Russia and Mexico, to cut production among its members in an effort to keep prices high. As a result, OPEC+ members have large spare capacity: estimates indicate they could produce 5 million barrels more per day than they are currently pumping. So even if, for example, Iranian oil exports were curtailed by an outright war with Israel, OPEC+ members could easily make up for it.

The oil production boom in the US has also made it more difficult for countries like Iran to use oil as a geopolitical weapon. Conflicts with Iran always raise the possibility that Tehran could try to close the Strait of Hormuz, a key oil tanker waterway that runs between Iran and the United Arab Emirates. But because America imports less oil than it once did, closing the strait today would have less impact on the US than on Iran – and would hurt Iran’s main buyer, China.

Other factors have also contributed to weakening the oil market’s response to the crisis. Over time, U.S. policymakers have become more willing to use the country’s Strategic Petroleum Reserve to soften the blow to consumers: Barack Obama used the reserve in 2011, when Libyan oil production went offline, and Joe Biden used him in 2022, after the Russian invasion. of Ukraine. The strategic reserve currently contains 383 million barrels of oil, so replacing Iran’s oil supply would not be a problem.

Meanwhile, economic growth, especially in China, is not necessarily translating into demand for oil as it once did. The boom in renewables for energy generation has, at the margin, reduced dependence on oil, as has the fact that fully electric and hybrid cars in the US now account for almost 20 percent of ‘light vehicles’ (essentially) for take their account. passenger cars) market, and probably a larger percentage of equivalent sales in China. In any case, oil traders are concerned these days about weak demand for oil from China, as Chinese growth rates have cooled dramatically in recent years.

Oil traders themselves may be less likely to panic if a geopolitical crisis erupts, because recent history shows that an overwrought response – such as panic buying that drives up prices sharply – is rarely justified. When a Houthi drone attack on oil facilities in Saudi Arabia shut down half of the country’s oil production in 2019, prices rose by almost 15 percent. But after the Saudis drew oil from their reserves and restarted production within weeks, prices fell quickly. Similarly, prices rose in 2022, when Russia invaded Ukraine, on fears of what Western sanctions could do to Russian oil production. But in less than two months the cost of a barrel was back to pre-invasion levels. In other words, what traders have learned is that betting on oil prices rising and remaining high due to geopolitical tensions is likely a bad bet.

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If Israel does that decide to bomb Iran, oil prices will still almost certainly rise. But the oil market would adapt and respond to that event in a way that would minimize its impact on global prices. And because traders understand these changing market dynamics, they appear to be dealing with this risk very differently than they once did. It is, of course, possible that the oil market has become excessively complacent. But what seems more likely is that resilience in some sense breeds resilience: because traders trust that the market will be able to deal with conflict, they are more likely to assess risk in a dispassionate way, rather than in a panicky way. That’s why many of us still pay only about $3 for a gallon of gasoline.