Analysts Believe Oil Market Is Underpricing Risk

In a report sent to Rigzone recently, analysts at Standard Chartered said they think geopolitical risk in oil has escalated significantly and the market is underpricing that risk.

“We think Iranian actions and statements on 13-14 April represent a significant escalation in geopolitical risk that is likely to persist for an extended period,” the analysts said in the report.

“We are not convinced by commentary suggesting that the scale of the Iranian attack on Israel was at the lower end of market expectations or/and was fully priced into the market before it happened,” they added.

In the report, the analysts said they detected little evidence that market participants were quantifying the likely scale of the attack in advance.

 “What discussion there was seemed to involve, at most, far fewer projectiles than the roughly 300 assorted drones, ballistic missiles and cruise missiles that were used,” they analysts noted.

“Likewise, we do not think the market expected Iran to draw new red lines quite so explicitly and in a way that would leave relatively little room for obfuscation and de-escalation after a future flashpoint,” they added.

“According to an Islamic Revolutionary Guard Corps (IRGC) statement on 14 April, Iran’s revised position is that any future attacks on Iranian interests anywhere will draw significant retaliation,” they continued.

The Standard Chartered analysts stated in the report that the IRGC seizure of a cargo ship on April 13 seems to have been intended as a related signal of Iran’s ability to influence regional shipping flows.

“In all, we do not think the oil market anticipated the scale of the attack, the new Iranian red lines (or ‘equation’ in the words of the IRGC statement) or the signal about shipping,” they added.

“Further, we think the market is understating the risk of further escalation due to miscalculation, miscommunication, or other human error,” they continued.

Also in the report, the Standard Chartered analysts said the company’s machine-learning oil price model, SCORPIO, “appeared to take the geopolitical turbulence in its stride”.

“The SCORPIO indication for Brent settlement on 12 April was $89.81 per barrel, which was just $0.19 per barrel less than the actual settlement; the market screens last showed $89.81 per barrel less than 20 minutes before settlement,” they added.

For settlement on April 19, SCORPIO indicates a price of $89.16 per barrel, with technical indicators and dollar strength the main sources of weakness, the analysts highlighted in the report.

Additional Stress

In a note posted on Morningstar’s website earlier this week, which was also sent to Rigzone, the company’s equity strategist, Stephen Ellis, said Morningstar believes the Iranian drone and missile attack on Israel over the weekend places some additional stress on the oil markets.

“However, we also think the ample public and private forewarning from Iran amid rising regional tensions means the attack was already reflected in oil prices via a higher geopolitical risk premium,” he added.

“We attribute nearly all the increase in oil prices (to around $91 a barrel from the mid-$70s in February) to geopolitical concerns rather than supply risks. On the supply side, Saudi Arabia and OPEC+ have about five million barrels per day of supply (if not more) that can be returned to the markets if prices overheat and spike above $100 a barrel,” he continued.

“We expect more downside risks than upside at the moment and see a higher potential to touch $75 by the end of 2024 versus a sustained movement beyond $100 a barrel,” Ellis went on to state.

Morningstar warned in an October 9, 2023, note that the major risk for the oil markets remains a direct escalation of hostilities between Iran and Israel, Ellis highlighted in the company’s most recent note.

“This is not that scenario,” he added.  

“We see it as a more limited retaliation for the earlier Israeli strike on the Iranian embassy in Syria. Iran has stated that with this attack, it considers the matter complete,” he continued.

“While we consider tensions in the region somewhat combustible, Saudi Arabia and Iran recently restored diplomatic ties. This suggests we are far from a scenario similar to the one that led to the 2019 attack on the Saudi Abqaiq oil facility, which temporarily shut down more than half of the country’s oil production,” Ellis went on to state.

Ellis also stated in the note that the U.S. and other G7 countries are urging Israel to consider its defense against the strike as a success and not retaliate.

“The risks to the oil markets remain material if the situation escalates further,” Ellis warned.

“Iranian oil production was about 3.1 million barrels per day as of February 2024. Increased U.S. economic sanctions against the country could reduce that amount by 500,000 barrels per day of production,” he added.

“A more dangerous scenario would be an Iranian attempt to close the Hormuz Strait, which handles about 30 percent of the world’s crude, mostly heading for Asia,” he said.

Ellis also highlighted in the note that Morningstar thinks U.S. increases in oil production “are an increasing counterweight to a potential conflagration in the Middle East”.

To contact the author, email andreas.exarheas@rigzone.com