How an Israeli invasion of Rafah could rattle the oil market

By Myra P. Saefong

Efforts to normalize Saudi-Israel relations may hinge on Israel choosing 'Rafah or Riyadh': analyst

Oil traders last week unwound part of the risk premium that has been built into prices since the start of the year, but there's growing concern that an Israeli invasion of Rafah in Gaza is all but certain - feeding volatility in oil prices Monday.

The physical oil market would not be disrupted by an event in Rafah, said Rob Thummel, senior portfolio manager at Tortoise. However, "the increased uncertainty tied to any retaliatory action taken by Iran could be reintroducing a geopolitical risk premium to oil prices." Iran is an ally to the Palestinian military organization Hamas, which controls the Gaza Strip and launched a deadly attack on southern Israel on Oct. 7.

Oil prices had posted losses last week, with U.S. benchmark West Texas Intermediate crude futures losing 6.9% and global benchmark Brent down 6%, with hopes of an Israel-Hamas cease-fire easing expectations over disruptions to the flow of oil in the Middle East.

Prices on Monday, however, settled with a modest gain after a brief dip.

There had been reports that cease-fire talks had come to an end, but news reports Monday afternoon said that Hamas has accepted an Egyptian-Qatari proposal for a cease-fire halt its war with Israel in Gaza. Israel offered no immediate response, however.

See: No comment from Netanyahu government in Israel as Hamas accepts cease-fire terms

Earlier, Israel military warned civilians to evacuate eastern Rafah as expectations of an imminent invasion of continued to grow.

On Monday, Brent crude for July delivery (BRN00) (BRNN24) settled at $83.33 a barrel on ICE Futures Europe, up 37 cents, or nearly 0.5%, while June WTI crude (CL.1) (CLM24) climbed by 37 cents, or 0.5%, to $78.48 on the New York Mercantile Exchange after trading as low as $77.91.

Price action remained limited, but some of the impact was related to the fear that Iran-backed Houthi rebels might intensify their attacks on oil tankers in the Red Sea, said Anas Alhajji, an independent energy expert and managing partner at Energy Outlook Advisors.

In late April, Houthis said they targeted a container ship in a drone attack in the Indian Ocean, which connects to the Red Sea, in solidarity with Palestinians against Israel's military actions in Gaza, according to a report from Reuters.

For oil, "it all depends on the reaction of the Houthis and any new development in other countries, as a reaction to events in Rafah," said Alhajji. "Without such reactions, any spikes, if any, are short lived."

Renewed fighting between Israel and Hamas could also impact any progress toward an agreement between Saudi Arabia and Israel to normalize relations.

The Biden administration has urged Israel against launching any major ground operation in Rafah, concerned that any such move would not only harm civilians but further isolate Israel in international opinion, particularly in the eyes of Arab nations as sensitive talks over normalization and postwar arrangements for Gaza were ongoing, according to a mid-April report from The Wall Street Journal.

The Biden administration has attempted to broker a Saudi-Israel deal, pushing Israeli Prime Minister Benjamin Netanyahu to accept a commitment to Palestinian statehood in exchange for diplomatic recognition by Riyadh, the report said. Meanwhile, the White House has offered Saudi Arabia a more formal defense relationship with Washington.

Saudi officials continue to insist that Israel normalization remains on the table, but "only if there is a credible path to a Palestinian state and end to the war," Helima Croft, head of global commodity strategy and MENA research at RBC Capital Markets, wrote in a note dated May 2.

"Hence, they pose it as more of a question of whether Israel wants Rafah or Riyadh," she said.

It is "hard to see how normalization can proceed at present" with Netanyahu suggesting that a Rafah offensive is imminent and offering "no indication of a willingness to reopen Palestinian statehood discussions," said Croft.

She also noted that while "energy assistance" was not explicitly discussed as formal component of negotiations toward a Saudi-Israel deal to normalize relations, there was an "implied assumption last autumn that Riyadh would be more amenable to [oil] production requests from Washington if the deal was concluded," said Croft.

That is particularly important for the U.S., with the presidential elections coming up later this year.

On Monday, state-owned oil giant Saudi Arabian Oil Co. (SA:2222), known as Aramco, raised the June price for certain crude grades to Asian customers and for all grades for costumers in northwest Europe and the Mediterranean, but not the U.S.

The higher prices suggests that the Saudis are not concerned about the potential for weaker oil demand, and likely contributed to prices gains for oil on Monday, analysts said.

For now, oil prices will "continue to reflect the evolving geopolitical situation to some degree," KPMG U.S. Energy Leader Angie Gildea told MarketWatch.

However, "absent any physical events that could disrupt supply or interfere with major trade routes, conventional wisdom remains that there is still enough spare capacity that could offset prices from being too high for too long," she said.

-Myra P. Saefong

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05-06-24 1600ET

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