Oil's war premium will fade after Israel's Iran strike

By Javier Blas

When it comes to oil and war in the Middle East, the moment to sell has been when the bombs start to fall.

The “buy the rumor, sell the fact” adage has held as the market realized that worst-case scenarios would be avoided. Back in January 1991, oil prices plunged just when US warplanes bombed Iraqi positions in occupied Kuwait. In March 2003, prices fell soon after US missiles hit Baghdad in the opening of the Iraq War.

Now, in the wake of Israel’s strike on Iranian targets, I believe the market will follow a similar pattern. While it would be wrong to completely dismiss the Israeli attack, the biggest aerial bombing the Islamic Republic has suffered in 40 years, the worst-case scenario hasn’t materialized. The situation is fluid, and much depends on how Tehran responds, but we can draw a few tentative, mainly bearish, conclusions.

1) Israel confined its retaliation to military sites. It didn’t hit either nuclear sites or oil fields. In doing so, Israeli Prime Minister Benjamin Netanyahu followed the advice from US President Joe Biden, who on Oct. 4 said: “If I were in their shoes, I’d be thinking about other alternatives than striking oil fields.” Iranian state-owned media quickly confirmed on Saturday that the oil industry was producing and exporting crude as “normal.”

2) So far, Iran is downplaying the Israeli bombing. State media called the strikes “weak” and claimed — falsely— that Tehran had “successfully intercepted” the attack. The commentary suggests an effort by the authorities to manage the narrative so a response against the attack is unnecessary. Oman, which typically serves as a go-between for Tehran and Washington, also pushed the same narrative. The Omani foreign minister said the “the damage appears limited” – diplomatic code for “let’s call it even and go back to the status quo prevailing a few weeks ago.” I see many reasons why that’s exactly what Tehran is going to ultimately accept.

3) The bullish oil narrative was centered on two elements: First, Israel would attack energy facilities in Iran; and second, that Iran could respond by targeting oil fields across the Persian Gulf in Saudi Arabia and other OPEC+ member nations. The first element of that narrative didn’t occur, and the second looks today even more far-fetched than yesterday. As I have written, the oil market hasn’t fully appreciated the change in tone of Saudi-Iranian relations, and how that shift has reduced the possibility of Iranian strikes against its neighbor. On Saturday, Riyadh took an important step: It publicly condemned what it called was the “military targeting of the Islamic Republic of Iran.” To me, it sounds as Saudi Arabia is doing its best to be left alone.

4) Still, the risk of unintended consequences is huge, and it would be careless to assume that tensions between Israel and Iran can be contained forever. As oil trading throughout this geopolitical crisis continues, one should remember former UK Prime Minister Harold Macmillan’s warning: “Events, dear boy, events.” The longer the crisis goes, the larger the risk too of the US enforcing oil sanctions against Iran, potentially reducing supply. That’s particularly likely if Donald Trump wins the election. That’s the only narrative left to the bulls because Iranian oil production has surged to a six-year high as the White House has until now turned a blind eye on sanctions.

5) Although Israel said all the targets were “military,” its message to Iran has important implications for the oil market. The Jewish state hit at least one target in Khuzestan province, the home of Iran’s oil industry. Tehran said two soldiers manning an air-defense facility in Ahvaz, the capital of the province, were killed. Ahvaz is, too, the largest oil field in Iran. I don’t believe in coincidences. To me, the message is clear: Israel is telling Iran its economic lifeblood is well within its range.

6) The attack was launched after the oil market had closed for the weekend, so there’s plenty of time for traders to digest the news. If — a big if — Iran doesn’t signal it would retaliate, it’s likely that the sell orders will prevail when the market reopens on Sunday night. By early Monday, the bulls would be racing against the clock. The Brent December options contract, which is the focus of lots of bullish $100-plus bets, expires by close of business in London Oct. 28. Without a catalyst for prices to move higher, those bullish options bets will expire out-of-the-money, opening the floodgates for sellers.

Bullish call options contracts, which give the holder the right to buy at a predetermined price, had been a magnet in recent weeks to push the market higher. Oil traders amassed a large cache of call options at $75 a barrel and higher, with huge exposures at $90, $95, and $100. But others have taken the opposite bet with bearish put options, which give the right to sell, at prices under $70 a barrel, and the market faces a big exposure in the $60 to $65 region that could act a trigger for lower prices.

7) If, as I expect, the war premium falls when the market reopens, traders will refocus on the bearish supply and demand outlook for 2025. The conventional wisdom now is that supply will run above demand early next year, with the only real debate about the size of the surplus. Giving the bears extra ammunition, the OPEC+ oil cartel is scheduled to start pumping more oil from December. All equal, more oil means lower prices. Even more so if the Israel-Iran war premium evaporates.