Gold prices are at record high, a sign that investors are fleeing to safe assets as the war in the Middle East expands. Israel is poised to attack Iran, the world’s seventh-largest oil producer. The oil infrastructure of Russia, the second-largest oil exporter, sometimes comes under attack by Ukrainian drones.
Given the rising geo-economic risks and possible oil-supply disruptions in crucial production regions, you would think that oil would be tracking gold higher and higher. Yet oil has fallen rather sharply recently and is down almost 20 per cent since the Israel-Hamas war started a year ago. How to explain this apparent disconnect?
Shortly after Russia invaded Ukraine in February, 2022, traders panicked and sent Brent crude, the international benchmark, soaring to US$120 a barrel from about US$80. Prices jumped again, rising almost US$10 a barrel, early this month as Israel attacked Hezbollah, the Iran-backed militia in Lebanon, and Iran retaliated by sending almost 200 missiles into Israel. Yet after each of these ferocious events, the oil markets regained their poise and fell.
The rise, then fall, after the Ukraine invasion is fairly easy to explain. In early 2022, the energy markets were tight. Oil was in fairly short supply as economies everywhere emerged from COVID-19 lockdowns, employees went back to work and factories and highways roared back to life. At the same time, the OPEC, led by Saudi Arabia, was trying to keep prices high by producing less.
The Saudi plan fell apart as various OPEC members and allies pumped more than their allotments and Russian oil exports, in spite of the sanctions and embargoes, proved remarkably resilient. Russia’s vast shadow fleet of tankers continue to ply the oceans. The upshot is that Russia continues to export almost as much now, about five million barrels a day, as it did before the Ukraine war. What Europe does not buy is eagerly snapped up by India and China.
The fall after Israel’s attacks on Hezbollah and Iran’s retaliation is a somewhat different story. At first, U.S. President Joe Biden hinted that Israel’s response would be an attack on Iranian oil assets. Prices rose by 10 per cent, at which point the White House apparently determined that adding a few bucks to the cost of a fill-up would win no votes for Democratic candidate Kamala Harris, who is in a dead heat with Donald Trump, the Republican contender. Since then, Israel has reportedly told Mr. Biden that it will not attack Iranian oil, nuclear or other non-military sites. It appears that Iran’s two million barrels a day of exports are safe – at least for now.
But if Israel is bluffing and does attack Iran’s oil industry, prices might not go wild even if they would certainly rise. That’s because the energy markets, unlike in 2022, are swimming in oil. Oil traded at US$73 on Friday, well below its 52-week high of almost US$94 even as Israel and Iran seemed on the verge of war.
OPEC now wants to increase output – it has ample spare capacity – in an apparent bid to regain, or at least not keep losing, global market share as non-OPEC producers, including Canada and Brazil, boost production and exports. Only five years ago, 44 per cent of oil came from non-OPEC countries; today, they supply almost 60 per cent. The International Energy Agency expects production from non-OPEC countries to rise by 1.5 million bpd next year.
At the same time, oil demand is weakening, especially in China. On Friday, China posted its slowest economic growth in a year and a half, with the economy expanding at an annual rate of 4.6 per cent in the third quarter, down from 4.7 per cent in the previous three months. The era of 10-per-cent growth is over. The upshot is that China will import less than expected this year and probably in 2025 (the rapid shift to electric cars is helping to reduce demand). “Chinese oil demand continues to undershoot expectations and is the principal drag on overall growth,” the IEA said this week.
Of course, wars are entirely unpredictable. Who would have thought that the war in Ukraine would still be raging today, with no end in sight, that the Israel-Hamas war would enter its second year, or that Lebanon would be invaded? Even if Israel avoids attacking Iran’s oil industry, Iran could attack the oil states in the Gulf, such as Bahrain or Kuwait, that it sees as Israel supporters. Were that to happen, oil would climb fast.
But would Iran risk such an audacious, potentially self-destructive move? China, which imports about half of its oil from Gulf countries, and the United States would not be amused. Nor would Saudi Arabia, which is trying to make diplomatic amends with Iran (last week, Saudi Crown Prince Mohammed bin Salman and Iran’s Foreign Minister Abbas Araghchi met in Riyadh).
Do gold investors know something that oil investors do not? Unlikely. The weakening dollar and interest-rate cuts seem to be propelling gold’s rise as much as geo-political tensions. Even if Israel and Iran were to get truly ugly with one another, a genuine oil crisis that would push prices to, say, US$120, seems unlikely, though not impossible. There’s a lot of oil around and the excess supplies can act as a crisis cushion – as long as the next crisis does not burn the entire Middle East