Oil Prices In 2024: All Eyes On The Middle East (Commodity:CL1:COM)

Given the Middle East crisis, I believe oil should trade much higher than it is trading now. Houthi attacks in the Red Sea have interrupted a lot of routes and negatively impacted world trade. More is yet to come, it seems. The conflict in Gaza is not over, unfortunately. There are bearish factors, however, holding the oil prices down. Among these are quite high shale oil production in the US and a likely recession ahead. I am not saying that oil prices will reach all-time highs. But I believe that the risks of a conflict in the Middle East are not fully realized by the market. In this article, I will explain why these matter.

Summary of my previous article on oil

I have been bullish on oil for a while. In October 2023, I published an article about the Israel-Hamas conflict and said the $200 price per barrel was well in the cards because countries other than Israel and Palestine, most notably Iran, were likely to get involved in the conflict. I said there was a possibility of Iran closing the Strait of Hormuz for all ships, including oil tankers. There are few chances to bypass the Gulf. Moreover, the fact that missiles are fired and infrastructure is destroyed in one Middle Eastern country means that oil production in neighboring countries can also be disrupted. These events can easily push the price of oil to $200 per barrel in my view. This has not happened so far. But it does not mean that it will never happen. In this article, I would like to cover the recent events that happened in the Middle East. These leave the door open to $200 per barrel, provided there is no economic recession in the near future.

The Middle East

Yemen’s Houthis have been attacking commercial shipping vessels travelling through the lower Red Sea since mid-November in reaction to Israel’s bombardment of Gaza. Threats have escalated to the point where Maersk, MSC, and other shipping giants have rerouted traffic. The US has organized a coalition in an attempt to defend ships against attacks.

This matters because the Red Sea is one of the most important shipping channels. It is located south of the Suez Canal, which is in turn the most significant waterway connecting Europe to Asia and East Africa.

The Red Sea’s southern end, the Bab el-Mandeb Strait, is the area that the Houthi rebels in Yemen have been targeting.

Almost 12% of global trade is tied to the Red Sea, including 30% of the world’s container traffic. So, delays can affect fuel prices, electronic goods, and the availability of other products. It is not clear when commercial shipping groups will renew the traffic through the Bab el-Mandeb strait.

This obviously raises global inflationary pressures. However, in spite of the Houthis’ attacks, there was no substantial surge in oil prices because, right now, the oil markets are not affected too much by the attacks. But there is a significant risk that the situation might escalate further.

Some analysts predict that the Houthis aim to get the US involved in a direct confrontation. Political experts say that escalation could also put peace talks between the Houthis, the military group supporting Hamas in the conflict, and Saudi Arabia, a US ally in the Middle East, under threat. The Saudis and the military group have been having a war since 2015. So, anything could potentially act as a catalyst for getting more Middle Eastern countries involved.

As I have mentioned earlier in this article, attacks on the Red Sea are closely linked to Israel’s ground war in Gaza. As it intensifies, Hamas and its allies appear to want to take the conflict to a broader arena to pressurize Israel. There were incidents that could have provoked further escalation in the war. For example, earlier this year in Beirut, 130 kilometers from the border with Israel, one of Hamas most senior leaders, Saleh al-Arouri, was killed in a strike. Israel was accused of the strike. A warning was issued by Lebanese caretaker Prime Minister Najib Mikati that the incident would drag Israel into a wider regional war.

Iran’s foreign ministry said the death of al-Arouri, one of Hamas leaders, will only embolden resistance against Israel in the wider Middle East. However, a senior Hamas leader, not Hezbollah’s or the Iranian Revolutionary Guards’, was killed. So, Iran did not respond. Hezbollah’s leader, Hassan Nasrallah, also condemned the killing but did not take any military measures.

In spite of Iran’s rhetoric, it still has not declared war on its enemies, including Israel or Western forces in the Middle East. According to Alex Vatanka, “nobody wants a war, so both sides have been gambling on the long term, hoping to kill the other guy through a thousand cuts.” That may well be true. However, the situation seems to be tense. Even though no one seems to want a full-scale war, I believe it might still happen and grow into a regional war. The Middle East is still accountable for large amounts of oil production, in spite of the US’s strong position in shale. I will analyze US oil production later on in my article.

OPEC+

Even if there is no full-scale war in the Middle East and global economic growth remains poor, OPEC likely won’t produce too much oil due to their conservatism. According to Fitch, the conflict in the Middle East is having a negative effect on neighboring countries, notably Egypt, Lebanon, and Jordan. But the agency expects oil-exporting countries in the Middle East to register better growth in 2024, thanks to stabilizing oil production after numerous output cuts in 2023. Fitch also predicts weak global growth in 2024 could prevent OPEC+ from cancelling 2023 output cuts. Indeed, there could be poor growth in 2024 from India and China, the main oil importers. The last deal on March 3, 2024, highlighted the oil organization’s reluctance to increase output. Fitch forecasts average growth to total 3.5% for the Gulf Council Cooperation countries, thanks to still-high oil prices. OPEC+’s policies still have a substantial effect on oil prices. But their decisions depend on economic conditions. But not the whole oil market is controlled by the Gulf countries.

Shale oil

US shale has been a revolutionary factor, greatly boosting the global supply of oil. In 2019, the total oil output in the US reached its peak but decreased somewhat following the 2020 pandemic.

US crude oil production in thousands barrels per day

The same is true of US oil reserves. These decreased after 2020 but are now rising, largely thanks to numerous government purchases for the Strategic Reserve.

US Crude Oil Reserves

Very interesting is also the situation with the US market share of global oil output. In other words, it kept growing until 2019. But then the growth stalled following that year.

US oil market share of the world’s output

My fellow Seeking Alpha contributor also wrote in his article that US shale oil growth is stagnating. Yes, crude oil production started increasing somewhat after 2021, but at a much slower pace compared to the previous periods.

US oil output reached a record of 12.93 million barrels per day in 2023. But the US Energy Administration cut its growth forecast for 2024 by 120,000 bpd to 170,000 bpd, quite a decrease compared to growth of over 1 million bpd in 2023. So, we can see that US shale production growth is clearly slowing down.

Upside risks

There are many factors that could potentially move oil prices upward.

• First of all, there is a risk of a full-scale conflict in the Middle East.
• Faster economic growth than planned—this is especially true of China and India. Many people, including myself, are expecting a recession. But what if there is a soft landing for the global economy? Then, the demand for fossil fuels and, most importantly, oil will increase.
• Environmental policies in the US. In the autumn of this year, there is a presidential election. If the new president is a Democrat, there is a risk that the new US administration will impose stricter environmental regulations. This will likely decrease US oil output.
• OPEC+ is adjusting production. This risk has already been discussed above.
• Further sanctions against Russia. Yes, there is a possibility that tougher sanctions against Russia may be imposed, which might lead to tighter oil supplies.

Downside risks

• Full-scale recession and demand destruction. In my view, this is the most significant risk influencing the market right now.

• Increased shale oil output. I have discussed this before, but it seems that the growth rate has decreased somewhat.

• OPEC+ price wars. In 2020, there was a price war between OPEC+ members, which in part made oil prices turn negative. A similar situation might repeat itself, but this is highly unlikely.

Oil’s valuations

Right now, oil is not trading at all-time highs.

This can be easily seen from the inflation-adjusted oil price graph below.

Inflation-adjusted oil prices

There was an unprecedented oil supply shock in 2020 when oil prices turned negative. But still, the S&P 500 is rather high compared to the current oil prices.

S&P 500/Crude oil prices

This can even better be seen in the graph below.

Crude Oil (blue) vs the S&P 500 (orange)

In other words, the general stock market is much more expensive than oil.

Conclusion

There are numerous risks that oil investors will face in 2024. The economic outlook might get worse. The oil supply is quite high. However, shale oil output is not growing fast, while OPEC+ might adjust its production levels according to the economic situation in the world. But the biggest upside risk, in my view, is that of a full-scale regional military conflict in the Middle East.