Schwab Market Perspective: Rolling Recovery?

• War returning to the Middle East, evoking memories of the 1973 oil embargo imposed by Arab countries in retaliation for support of Israel during the Yom Kippur War, which resulted in a quadrupling of oil prices in just three months.
• Houthi militants attacking oil tankers in the Red Sea, a route traversed by around 12% of seaborne oil.
• Ukraine targeting Russian refineries. Ukraine's campaign is moving toward taking the war inside Russia's borders, focusing on attacks on energy and transport infrastructure.
• Iran blaming Israel for the precision airstrike that killed Iranian military leaders in Syria and pledging vengeance.

Yet historically, the geopolitical impact on oil prices tends to be short-lived. For example, immediately after the 9/11 attacks, crude oil prices jumped by about 5%. However, within 14 days, the price subsequently dropped by around 25% on concerns about recession. To further illustrate, when Russia invaded Ukraine on February 24, 2022, oil prices increased roughly 30% over the following two weeks, and then slid back to their pre-invasion level two weeks later over concerns about weak economic growth and softening European oil demand. Even more recently, oil prices increased by about 4% before retreating after the Hamas attacks in Israel on October 7, 2023. Despite all the geopolitical tension over the past 10 years, oil hasn't sustained a move above $90, excepting the few months following Russia's invasion of Ukraine in 2022 which drove a reallocation of global supplies due to sanctions.

Worsening geopolitical tensions could potentially drive further gains. However, prices are near the high end of the range of the past 12 months and there are a few factors which could limit the sustainability of any additional surge.

• First, global oil production is now less concentrated in the Middle East than it has been since the 1970s. Production from Saudi Arabia and Russia has slowed since the mid-2000s, while U.S. production has more than doubled thanks to the shale boom of the 2010s, which turned the U.S. into a net energy exporter for the first time since at least 1949. In that same decade, Canada began to extract crude from the oil sands in Alberta, boosting its production. Despite sanctions from the EU and the U.S. following the invasion in Ukraine, oil from Russia, the world's third-largest producer, has continued to flow, now largely to Indian and Chinese refineries.

• Second, OPEC members now have ample spare production capacity. When production is tight, exporting countries have little room to respond to increases in demand or shocks that can curtail output and cause prices to spike. The EIA estimates that OPEC's core members have around 4.5 million barrels per day of spare capacity, a sizable cushion roughly equivalent to the total output of the fifth largest oil producer in the world.
• Third, while oil demand is expected to continue to rise along with economic growth, the pace of demand growth is predicted to be much slower than in recent years, according to EIA forecasts. That implies the balance between oil supply and demand might remain tilted toward oversupply for the coming years. Notably, China, the world's second largest oil consumer, is likely to see soft demand in the near term as its economy struggles to find momentum.

Despite current geopolitical risks, these additional factors suggest that the price of oil seems unlikely to sustainably appreciate further, derail disinflation, or curb economic growth.