Prices fell when everyone was expecting a sudden spike after Iran attack
By K Raveendran
Oil has spooked the market by registering a fall in prices when it was widely expected that Iran's retaliatory strike on Israel over the weekend would lead to an instant spike. Not only that the spike did not materialise, but prices fell in a well-telegraphed response that baked in any risk to crude supplies in the wake of the mounting tensions.
The response is considered just right from the point of view of India, which is facing a crucial election that the opposition parties believe will determine the country's destiny. An oil price hike would have caused additional headache to the ruling party and the Modi government.
As the risk to supply is waning and a military response from Israel looks less likely as more time passes, prices are holding steady. This is in spite of tensions remaining high, and either party's next moves are hard to predict, although all significant signs point toward an easing of hostilities and restraint in the short term.
But one thing is for certain: volatility is here to stay as further escalation in the Middle East cannot be ruled out – something that would rapidly increase the geopolitical risk premium in the oil market. According to Rystad Energy experts, the most likely scenario now is for all sides to show restraint in the coming days and weeks for a few reasons, even though Israel's military chief has just announced that the nation would respond to the weekend strike.
The first one is that it now seems clear that the Iranian strike was a well-calibrated retaliatory action, with the goal of demonstrating maximum force but with minimal likelihood of casualties. This fulfilled two important objectives for the Iranian regime: placate internal pressure to react, and deter Israel and cause damage but remain just short of a threshold for an escalation.
The Iranian attack was well articulated to the key actors days in advance, giving enough time to Israel and its allies to prepare. Moreover, it is known that Iran targeted only military facilities, which shows a great degree of caution on Tehran's side. It is also significant that Hezbollah did not participate in the attack.
The second reason is the Iranian position after the attack. Invoking Article 51 of the UN Charter, Iran argued that its offensive was a legitimate act of self-defence in response to an attack on its consulate in Damascus.
Underscoring the point, the Permanent Mission of the Islamic Republic of Iran to the UN declared that “the matter can be deemed concluded,” indicating no further plans for aggression on its part.
The third reason why Rystad believes there might not be a further escalation in the coming days or weeks is Israel's position after the attack. Internally, the Saturday event is being seen as a major victory for the Israeli government in defending its people. This reduces the political pressure on Prime Minister Benjamin Netanyahu to retaliate further. It also removes some of the pressure on him to resign, following mass protests calling for his resignation in recent weeks.
The fourth reason is that the attack on Israel takes the focus off Gaza, at least for some time. This means that there might be less pressure on Israel to show restraint on Gaza to achieve its military objectives. Importantly, the Iranian attacks have removed some of the rising diplomatic isolation for Israel that has gradually become evident in recent weeks as it continues its offensive in Gaza. And it also brings closer US – Israeli relations that are strained due to Netanyahu's refusal to entertain a ceasefire to allow more humanitarian aid, as the prospects of famine and illness worsen. Arguably, this is a big external asset that Israel would want to preserve, avoiding further escalations.
The fifth reason cited by Rystad is that Israeli allies have been very vocal in pressing the nation to avoid a further escalation.US President Joe Biden has warned that Washington would not assist any counter-offensive against Iran. UK's foreign secretary David Cameron also made it clear that the UK would not take part in an attack on Iran but would continue to defend Israel if it came under further assault. They were joined by French President Emmanuel Macron, who said that his government will do everything to avoid an escalation in the Middle East.
The energy experts consider this as important because Israel repelled the Iranian attack with the explicit help of the US, the UK and France. However, an Israeli attack on Iran might not find support in these allies. Finally, it is believed that the Gulf states will leverage diplomatic ties with Washington and Tehran to prevent a wider regional conflagration. It is in their best interest to showcase their growing foreign policy clout.
The mainland China-led agreement in March 2023 to restore Saudi Arabia–Iran relations and the US-led Abraham Accords to restore diplomatic ties between Israel and the UAE and Bahrain, signed in September 2020, play an important role. In addition, enabling continued focus on economic modernization plans, a top priority for Gulf states, requires regional geopolitical stability.
Rystad believes that attacks between Israel and Iran's proxies in Lebanon, Syria and Yemen will continue in the coming weeks. At the same time, there may be less pressure on Israel to show restraint in Gaza.
Correspondingly, the likelihood of a ceasefire between Israel and Hamas is lower now than a few days ago. If there is one surety, it is that geopolitics will play an even bigger role in the oil market in the coming days and weeks. As such, significant volatility may be expected in near future.
