Israel Reminds that Geopolitical Events Are Biggest Factors in Determining Oil Prices

Israeli air strike in Gaza Image: AP/Ariel Schalit

Until the fall of 2008, voters and political pundits seemed to agree that the deciding issue in the upcoming presidential election would be the war in Iraq.  Many cited Barack Obama’s firm anti-war stance as an important factor in his victory in the Democratic primaries and caucuses.  By election day, however, the Iraq war as a political issue was all but forgotten.  With the mortgage industry imploding and stock markets plummeting, polls consistently showed voters cared most about the economy and how to fix it, with the Iraq war often ranking a distant third (after health care reform).

A parallel story could be told about oil prices since October of this year.  Once the economic “downturn,” (now officially a “recession”) came into focus, crude prices dropped at a record pace.  Every new crumb of economic data–climbing unemployment, slumping retail sales, manufacturing slowdowns–knocked oil prices down a peg.  The cycle of negative economic news and falling oil prices has made it difficult to remember what, if anything, besides economic developments can have an effect on oil prices.

Enter Israel, with a bang.  On Saturday, the Israeli military began a devastating attack on the ruling Hamas party in the Gaza strip, and plans to continue attacking until Hamas in Gaza has been effectively demolished, according to a BBC story.  As the commodities markets opened on Monday, the price of crude oil and heating oil shot up as a result of fears that the conflict in Gaza could obstruct Middle East oil supplies.  The question is, why would a military conflict between two nations that are neither major consumers nor producers of oil have such a profound effect on oil prices?  The answer is simple: perception and emotion.  While neither Israel nor Gaza are major components in the machinery of the world oil market, they are located in a region that produces the vast majority of the world’s oil.  Theoretically, Hezbollah militants could enter the fray in support of Hamas, which could lead to Iran taking Hamas’s side in the conflict as well, which could mean Iran reducing or cutting off oil exports to Israel and its allies, including the United States.

That is just one of several possible scenarios that could lead to major supply disruptions and drive up the price of oil.  Although unlikely, these scenarios help form a perception of instability in the Middle East and conjure images of political strife causing precious oil exports to slow to a trickle.  The important lesson here is that headline-grabbing world events, not economic data, hold the most sway over oil prices.  HEAT USA President Andrew Heaney touched on this fact in his Q&A session with HEAT This Week a few weeks ago when he made his predictions for oil prices over the next few years: “I think the price of oil will hover between $30 and $70 for the next couple of years, with a good amount of volatility due to geopolitical events, not economic ones.”  Certainly, Israel’s assault on Hamas in Gaza is the first such volatility-inducing event.

However the conflict ends, it is fairly certain that it will have no direct effect on worldwide oil supply or demand.  However, it will continue to affect the perception of oil and the nations that produce it, and that perception could prove to be more influential than any economic or technological realities.