How Will the Israel-Hamas Conflict Affect Oil Prices?

By Alexander Stevens and Caleb Jasso

Following the Oct. 7 attack on Israel, oil prices rapidly surged due to concerns about the potential for an expanding geopolitical conflict in the Middle East. Since then, however, lingering concerns about global oil demand have actually driven prices lower, with West Texas Intermediate crude oil prices sitting around $73 per barrel at the beginning of December.

Nevertheless, the developing conflict in the Middle East remains a concern for its potential to drive volatility in the oil market. The conflict once again underscores the negative effects of policies that block the development of our domestic energy economy here in the United States. During the ongoing Israel-Hamas conflict, oil prices will likely be influenced by three key geopolitical factors: the extent and nature of the conflict, the impact of U.S. sanctions on Iran and OPEC+’s production decisions following its November meeting.

Conflict Escalation

With thousands already dead and displaced, despite the uneasy temporary cease-fire that ended on Dec. 1, the threat of a larger war throughout the Middle East is still present and remains the primary risk to volatility in the oil market. Two ways the conflict may spread are by Hezbollah’s direct intervention in southern Lebanon and by the possible actions of Iranian-backed militias operating in Syria and Iraq and of the Houthis in Yemen.

Israeli and Hezbollah forces have repeatedly clashed on Lebanon’s southern border since the outbreak of the war, and Iranian-backed militias have taken the opportunity to attack U.S. military bases in both Syria and Iraq. These actions, coupled with the recent missile launches from Houthi-controlled Yemen toward targets in Israel, including the port city of Eilat, paint a bleak image for what may still be to come. Additionally, on Dec. 3, Houthis fired upon three commercial vessels in international waters in the southern Red Sea. The USS Carney responded to their distress calls and shot down three drones in the process. The Houthis also claimed two additional attacks on two Israeli vessels in the area.

If Hezbollah and Iranian-backed militias see an opportunity to directly involve themselves in the war, they very well may. If the war becomes one of extraordinary attrition and weakens Israel’s ability to fight a multi-front war, Iran may seize the opportunity to expand its military operations in the region via its supported militias to further weaken Israel. However, this expansion would take a great deal of time, as Israel is still highly capable of waging a multi-front war both physically and monetarily.

The main concern as it relates to the oil market is that direct intervention by Iran and Hezbollah would rapidly turn the war into a conflict encompassing the entire region. Iran could potentially make passage through the Strait of Hormuz impossible or impractical. Such action would increase the price of oil significantly due to the fact that approximately one-fifth of the world’s total volume of oil consumed passes through the strait—20.5 million barrels per day (bpd) of crude oil and oil products from January through September of 2023. That being said, closing the strait is highly unlikely given the international pressure that would result: Neighboring Saudi Arabia, Kuwait and Iraq, as well as Iran itself, are heavily reliant on revenues generated by access to the strait.

The threat of the Israel-Hamas war expanding into a greater regional conflict will continue so long as the war continues. Israel’s approach toward military action in Gaza must be tempered with an eye toward limiting escalation of the conflict within the region, as Hezbollah and Iran will continue to look for windows of opportunity to disrupt Israel’s efforts and to further their own interests, which easily could lead to wider conflict.

Sanctions on Iran

Another factor that will shape the trajectory of oil prices during the conflict is the approach the U.S. takes toward Iran. Sanctions on Iran have been in place since 1979 and have fluctuated in their intensity. Today, “U.S. sanctions on Iran block Iranian government assets in the United States, ban nearly all U.S. trade with Iran (except food and agricultural commodities, medicine, medical supplies, and humanitarian-related goods), and prohibit foreign assistance and arms sales.”

In the context of the Israel-Hamas war, it remains to be seen whether additional sanctions will affect Iran’s ability to project power via proxy groups, including Hezbollah and Hamas itself. As of Nov. 29, the U.S. Treasury Department had sanctioned 20 additional companies and individuals, including Iranian Sepehr Energy for its direct connection to the financing of the Iranian military, as part of the ongoing effort to diminish Iran’s ability to project power regionally.

Even with the new sanctions imposed last month, Iran continues to increase its crude oil exports. The country reported output of 3.1 million bpd for October, which means, according to the Energy Information Administration, Iran has increased its overall output by more than 500,000 bpd since January. This rise in oil production and sales is attributed to multiple factors, specifically, Iran’s exemption from the OPEC+ production cut agreement due to U.S. sanctions, and the rise in sales to China. China has taken advantage of the situation to import oil at a highly advantageous price, accounting for 1.05 million bpd of Iranian oil exports from January through October 2023.

Sanctions are often considered an effective tool for exercising soft power in the form of economic pressure. However, if the Biden administration continues to allow for the illicit sale of Iranian crude in such large quantities—especially to China, which has only allowed two direct imports to be recorded since 2020—Iran will continue to have the funds to maintain and potentially expand its ability to project power regionally. Such an ability would give Hamas the capability to draw the war out significantly longer, which raises the possibility of more parties involving themselves and the conflict spilling over into neighboring countries. But stepping up the intensity of U.S. sanctions is also risky: Removing Iranian oil from the market completely, or nearly completely, poses a threat of increasing oil prices for all consumers.

OPEC+ Production Decisions

The final geopolitical factor that will influence the trajectory of oil prices in the wake of the Oct. 7 attack on Israel is the production decisions following the November meeting of OPEC+.

On Nov. 28, OPEC+ took steps to counter declining prices by reducing oil supply. The group issued a statement that refrained from officially endorsing production cuts. However, individual countries independently declared voluntary reductions amounting to 2.2 million bpd for the first quarter of 2024, with Saudi Arabia, as the pivotal and largest member, taking the lead in this initiative. It’s important to note, though, that these supplementary cuts are not formalized in a binding agreement. Instead, the group's statement indicates that member nations will voluntarily implement them, introducing uncertainty about their long-term sustainability.

The Saudi Press Agency, quoting a source in the Ministry of Energy, reported that Riyadh has agreed to prolong its voluntary production reduction by 1 million bpd. Russia has also intensified its voluntary supply reduction to 500,000 bpd until the end of the first quarter of 2024, as stated by Deputy Prime Minister Alexander Novak.

In addition, several other countries have announced their respective voluntary cuts for the first quarter of 2024:

• Iraq: 223,000 bpd

• United Arab Emirates: 163,000 bpd

• Kuwait: 135,000 bpd

• Kazakhstan: 82,000 bpd

• Algeria: 51,000 bpd

• Oman: 42,000 bpd

Despite lower production, however, oil prices fell in the wake of OPEC+’s announcement, signaling that lingering concerns about global demand for oil remain the main factor in driving prices.

Toward U.S. Energy Security

The impact of recent geopolitical events on oil prices has been largely muted due to lingering concerns about slowing global demand for oil. However, the potential for escalation of the Israel-Hamas conflict shows the need for developing alternate energy resources within the U.S.

To safeguard against geopolitical shocks such as the Israel-Hamas war, it is essential to free up the American energy economy. This approach empowers both companies and households in the U.S. to shield themselves from volatility stemming from geopolitical risks—much as it did at the beginning of the Russia-Ukraine conflict. We need to shift away from the misguided policies that needlessly block American energy production and to embrace a mindset of energy abundance in which all our energy sources are allowed to thrive in a competitive market. This policy shift would help stabilize prices and blunt the effects of geopolitical shocks like those stemming from the ongoing conflict between Hamas and Israel.