Fuel for Thought: A Middle East oil embargo is irrational, not unthinkable

Oil prices are reflecting the view that a 1973-style Arab embargo on oil exports is an extremely unlikely response to the crisis in Gaza. They signal Middle East producers keeping oil shipments flowing and geopolitics separate as the only rational scenario.

However, leaders of OPEC’s largest producers have a track record for acting irrationally at times, often when markets least expect it.

Platts Dated Brent was assessed at $88.615 on Nov. 1, back to levels last seen before the Oct. 7 assault by Hamas militants triggered the war with Israel.

The main case against another oil price shock occurring is political. Saudi Arabia and the United Arab Emirates are natural enemies of the Iran-backed Hamas, the primary protagonist fighting Israel in Gaza. Aside from calling for an immediate cease-fire on humanitarian grounds it is in the national interest of neither to use their oil exports to bring about an end to the conflict.

Prior to Hamas attacking Israel, the UAE had normalized political and economic relations through the Abraham Accords. The US hoped a similar deal could be struck between Riyadh and the government of Israeli Prime Minister Benjamin Netanyahu. Fears the war could engulf the entire region, not an embargo, is what worries oil traders most.

Unlike today, the oil shock prompted by the Yom Kippur war 50 years ago was rooted in the febrile political backdrop of Pan-Arab nationalism, the Cold War and a Saudi-led movement for Islamic unity espoused by its then ruler King Faisal bin Abdulaziz al-Saud. The distant uncle to current de facto leader Crown Prince Mohammed bin Salman hoped his actions would unify a fragmented Arab world.

By 1974, global oil prices had increased by 300% after OPEC imposed targeted embargos on exports to the US, UK, the Netherlands, Japan and Canada, in response to their support for Israel in the war against Egypt and Syria.

Pressure to weaponize oil exports from the Arab street is also mostly absent today unlike 50 years ago. Of OPEC’s core Gulf states, it is Kuwait -- its rulers under pressure from Islamists within the elected National Assembly -- who have been the most forthright demanding a cease-fire. Algeria and Oman too have been critical of Israel. The latter has seen small street demonstrations in the capital Muscat.

Compared with the leading role in orchestrating the embargo in 1973, Saudi Arabia’s current rulers appear ambivalent.

Symbolism and $150/b

Economics have also changed a lot since then. In 1973, the Middle East accounted for more than a third of the global oil market, that number has now fallen to below 30%. At the same time, US production has surged, accounting for the biggest share of global oil output on the back of shale.

Major consuming nations are more resilient. The International Energy Agency requires countries to hold 90 days of forward cover, while major economies led by the US, China and India maintain their own strategic oil reserve buffers.

Despite a more robust oil market, any major disruption to supplies from the Middle East would surely be bullish for prices. The World Bank in its latest Commodity Market Outlook published last month warned $150/b oil was a plausible outcome if hostilities escalated across the region.

Iran -- a key backer for Hamas, Hezbollah and Houthi militants in Yemen -- has been warned not to spread the conflict further. The OPEC producer has formally called for "Islamic governments" to impose a targeted embargo on oil sales to Israel.

The semiautonomous Kurdistan Regional Government in Iraq, where Iranian-backed militia also hold considerable sway, was the largest supplier of crude to the Jewish state in 2023 until shipments loaded from the Ceyhan pipeline were disrupted by its closure earlier this year, according to S&P Global Commodity Insights data.

Kazakhstan and Azerbaijan account for the largest share of Israel’s 300,000 b/d of crude imports. Although both countries are members of the Organization of Islamic Cooperation -- which also includes OPEC producers Saudi Arabia, the UAE, Iraq, Kuwait, Algeria, Nigeria and Gabon -- neither is likely to heed the calls from Iran’s Supreme Leader Ali Khamenei made on Nov. 1 for an embargo.

"An oil embargo on Israel would be more symbolic rather than damaging," said Jim Burkhard, vice president and head of research for Oil Markets, Energy and Mobility, S&P Global Commodity Insights. "The US alone exports 3 million-4 million b/d of crude oil, so the US, at the very least, could replace any lost oil."

Even a limited blockade on oil shipments to Israel would impact global oil markets but also likely anger Iran’s key international ally China -- the world’s largest importer of crude. Despite this, Tehran is likely to persist when OPEC and Russia meet in Vienna on Nov. 26 for their final gathering of 2023. However irrational an oil embargo may sound, the group is unlikely to avoid having to discuss the unthinkable.