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Tensions in the Red Sea: what’s happening with oil?

Feb 7, 2024

Redacción Mapfre

Redacción Mapfre

Hamas’ attack last October and Israel's response have had consequences beyond its borders, specifically in the Red Sea, where the Houthis, a Yemeni militia allied with Hamas and Iran, have been attacking commercial vessels since November. This triggered a response from the United States, which has carried out several attacks in collaboration with the United Kingdom, launching more than 70 strikes against the Houthi militias in Yemen, among other actions.

The lack of stability in this region is always a cause of concern for analysts. In this case, attacks in the Mandeb Strait, which connects the Red Sea to the Gulf of Aden, could have a major impact on international trade, as it’s one of the busiest trade routes. However, there’s greater concern about the impact that an escalating conflict could have on the price of raw materials such as oil.

In fact, energy markets and geopolitical conflicts are two of the risks to the global economy identified by MAPFRE Economics, MAPFRE's research arm, in its report '2024 Economic and Industry Outlook: The First Quarter', published by Fundación MAPFRE.

The markets appear to have stabilized, despite the initial surge in safe-haven assets like gold and oil prices and indications from the Organization of the Petroleum Exporting Countries (OPEC) of potential new supply restrictions, which would push prices up.

The Brent crude oil barrel price, the benchmark in Europe, is currently trading between 75 and 80 dollars per barrel, after a significant drop last week. This is also the case for the WTI crude oil barrel, the benchmark in the United States, which is trading at just over 70 dollars per barrel. Thus, crude oil is still far from the 97 and 95 dollars per barrel at which they peaked in September, respectively.

The MAPFRE Economics report also includes gas within this risk scenario, more on account of the conflict in Ukraine than tensions in the Red Sea. As regards oil, it seems to remain relatively stable, and far from the peak seen in 2022, when it hit 292 euros per MWh.

“Strategic reserves and increased capacity for importing liquefied gas from the United States, unaffected by maritime transit issues, sustain consistently higher prices, influencing long-term inflation resistance without the dramatic spikes witnessed two years ago,” explains the report.

 

What can we expect from commodities in 2024?

In preparing its Outlook report, MAPFRE Economics always calculates two scenarios, which makes even more sense at present when there are more and more exogenous factors that can influence economic performance. In the baseline scenario, which is the most probable and, in this case, optimistic scenario, the Research Service predicts more stable energy and food prices. Specifically, the oil price forecast has been revised downwards compared to other editions of the report and is at levels very similar to those currently being traded: 75 dollars per barrel versus 80 dollars per barrel forecast three months ago, due to increased production in the United States, the plans of OPEC to extend voluntary output cuts until the end of the first quarter of 2024, and the commodity markets’ subdued response to the geopolitical conflicts.

MAPFRE Economics is also preparing a more stressed scenario, with an escalation of the war between Israel and Hamas and the conflicts in the Red Sea, which would see an increase in inflation due to the price of oil rising to 120 dollars per barrel. The price of crude oil would remain tight during the first half of 2024, with higher equilibrium prices in the medium term, in the range of 90 to 95 dollars per barrel.

“These events lead to increased volatility, which can last from hours to several days, while the market puts a price on the ultimate scenario. The current scenario is uncertain, as some are predicting a large-scale conflict, while others are saying it's not likely. We certainly hope not. If this were the case, the impact would be rather limited. We would have to look at the consequences for oil prices, for example, because wars are inflationary,” explains Alberto Matellán, Chief Economist at MAPFRE Inversión.

 

How does the oil market work?

There’s a direct correlation between economic growth and demand for oil, which pushes prices up. MAPFRE Economics predicts a weakening of economic activity worldwide, which will be more noticeable in Europe than in the United States. It isn’t surprising that the price of crude oil hasn’t skyrocketed then, despite tensions in the Red Sea.

Specifically, global GDP is expected to increase by 2.3% this year, compared to an increase of 3.1% in 2023, and then recover in 2025, growing by 2.6%. Should the situation in the Middle East become more complicated, with an escalation in the conflict and the involvement of other powers, growth would be diminished, although this wouldn’t mean that there would be a global recession: GDP would continue to grow, although it would only do so by 1.4%, rising to 1.5% the following year.

“This is where we believe the danger lies, given the possibility that oil-exporting countries like Iran or others may take more direct action and restrict supply,” highlights Matellán.

What's more, consideration must be given to the fact that this raw material is very scarce and is not evenly distributed in the earth's crust. The world’s main oil producers are members of OPEC. Founded in 1960 by Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela, it now consists of 13 members: Qatar, Libya, United Arab Emirates, Algeria, Nigeria, Angola, Equatorial Guinea, and Congo, who joined the five founding members.

The organization's mission is “to coordinate and unify the petroleum policies of its Member Countries and ensure the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers,” as explained on its website.

The meetings of this organization always arouse interest among investors and analysts, as OPEC has the power to increase or reduce the number of barrels of oil produced, which also impacts their price: when production increases, the price tends to go down because there’s a greater supply of the raw material, and when they decrease production, the opposite occurs.

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