Oil shock? How OPEC+ could soften the blow if the Middle East conflict hits supply.

By Myra P. Saefong

Replacing lost barrels is not as simple as 'flipping a switch', one trader notes

Oil prices have climbed so far this week, with traders worried that Israel may decide to hit Iran's oil infrastructure in retaliation to Tehran's missile attack - but the market has a not-so-secret cushion that could help offset any loss of output.

"OPEC+ has 5.8 million bpd [barrels per day] spare capacity to compensate for Iran's 1.7 million bpd of discount sanction barrels," said Robert Yawger, director of energy futures at Mizuho Securities USA.

OPEC+ - comprised of the Organization of the Petroleum Exporting Countries and its allies - was already preparing to lift output in less than two months. The group has plans to gradually faze out voluntary production cuts of 2.2 million bpd, with the reinstatement of 180,000 bpd beginning in December.

It made that decision in early September, before Iran's Tuesday missile attack on Israel raised the risk of production and supply disruptions in the oil-rich Middle East.

That said, if Iran's output were significantly curtailed, replacing the lost barrels wouldn't be "as simple as flipping a switch," said Stephen Innes, managing partner at SPI Asset Management.

"It takes time, especially with war-ravaged supply chains adding more obstacles to the mix," he said.

The real drama pushing prices higher recently wasn't Iran's missile strike; rather, "it's the looming question of how Israel might retaliate that's got everyone on edge," Innes said. "Forget the immediate physical damage; the real fireworks would come if Israel aimed for Iran's economic jugular - its oil production."

That would be a recipe for near-term volatility across markets. "If Israel cripples Iran's oil industry, global markets will be left scrambling to catch up," Innes told MarketWatch in emailed commentary.

Also, expecting the U.S. to ramp up production significantly beyond current levels would be a "tall order," he added. The industry is "already pushing hard, and any additional boost would take time and resources, neither of which are in endless supply."

Oil prices have found support from the threat to global supplies. On Wednesday, global benchmark Brent crude for December delivery (BRN00) (BRNZ24) climbed 34 cents, or 0.5%, to settle at $73.90 a barrel on ICE Futures Europe, while U.S. benchmark West Texas Intermediate crude for November delivery (CL.1) (CLX24) rose 27 cents, or 0.4%, to settle at $70.10 a barrel on the New York Mercantile Exchange. Both ended at their highest in two weeks.

Brent prices climbed 2.6% on Tuesday when Iran launched missiles into Israel - partly in retaliation to Israel's military operations in southern Lebanon against Iran-backed militant group Hezbollah - and were up more than 5% at session highs. Tuesday's percentage gain was the strongest in five weeks.

Read: What Iran's missile attack on Israel means for oil prices

Still, some would point out that the oil market isn't in dire need of additional barrels at the moment. Brent and WTI prices remain negative both on the year and compared to where they were 12 months ago.

The worries about supplies in the Middle East come in stark contrast to expectations for a global slowdown in oil demand, particularly when it comes to China.

"The market does not need more barrels," especially with Chinese demand down around 3% on the year, Mizuho's Yawger told MarketWatch.

"China has been the global demand-growth engine for years, but those days may be over as the economy cools and the consumer increasingly turns to the [electric vehicle]," he said.

OPEC+, meanwhile, made it clear Wednesday that it's important for its members to make up for past overproduction. After a meeting of its monitoring committee, the group said Iraq, Kazakhstan and Russia confirmed that they have "achieved full conformity and compensation" for overproduction based on the schedules submitted for September. The committee even said there were technical workshops for the three nations to discuss their September output and submit revised compensation plans that include overproduction in August.

"Stick to the rules, and producers might just get to have their cake and eat it too," said Innes.

"They've got some good fortune on their side as well - Chinese stimulus is poised to flow through the mainland economy soon, giving it a much-needed boost," he noted. Add to that the Federal Reserve's recent interest-rate cut, which could help restore some of America's shaken economic confidence, and "you've got a recipe for optimism in the market."

"All the pieces are in place - now it's just a matter of seeing if they fall into place as expected," Innes said.

While OPEC+ is asking certain members to make up for cheating on their quotas and cut back on production, the rest of OPEC+ is looking to raise output before the year is done.

Saudi Arabia wants to "claw back market share it has forfeited since production cuts started in the wake of negative pricing" on Nymex in April 2020, Yawger said.

"Since then, OPEC+ has theoretically taken around 5.8 million bpd of supply off the market," while U.S. production has increased by 200,000 to 300,000 bpd, he said. Additionally, Canada and Brazil have "stolen market share and Guyana has come out of nowhere to grab market share."

Saudi Arabia is making noise - and "starting to sound a bit close to 'market-share clawback' at the expense of price," said Yawger. The Saudis are adding production even if others are overproducing, and that "equals too many barrels," he noted.

Even so, oil prices, at least on Tuesday, saw a real reaction to a real threat to global crude supplies. On Wednesday, those worries seemed to fade and gains became more modest.

Some analysts expressed doubts that Israel would even hurt Iran's oil infrastructure directly.

If Israel were to retaliate against Iran, it would likely target refineries and not oil facilities or ports, said Anas Alhajji, an independent energy expert and managing partner at Energy Outlook Advisors. That's because the output from refineries goes toward domestic use.

The dilemma for Israel, if it were to target oil facilities or export terminals, would be higher prices, Alhajji said. That could anger the Biden administration, which doesn't want to see higher oil prices before the presidential election, he added.

Besides, if Israel does attack Iranian oil infrastructure, Yawger believes there's lots of OPEC+ production that could make up for the losses.

-Myra P. Saefong

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10-03-24 0501ET

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