Conflict in the Middle East and the impact on the oil price

Seven months on from the crash that saw prices plummet to around $50 an energy watchdog said that a recovery seems “inevitable”.

Mamdouh Salameh, an international oil economist, says the glut that has driven down prices since June could start to ease as soon as the second half. He pointed to issues recently highlighted by Precise Consultants – the US oil refinery strike, the pull back of shale oil rigs and reduction in global investment, telling Reuters “All these combined are giving signals to the global oil market that production is going to fall and that will put a huge floor under the oil price and start pushing it up.”

Another factor is the ongoing conflict in the Middle East. The conflict is in Yemen and it’s been backed by Iran and Saudi Arabia. Iran is supporting the Houthi rebels who marched on the southern Yemeni port city of Aden, where Yemen’s President Abdrabbuh Mansour Hadi fled to when he left the capital Sana’a. That action was met by airstrikes launched by Saudi Arabia, supported by regional allies the United Arab Emirates, Bahrain, Qatar and Kuwait.

Analysts fear tensions here may develop into a conflict which would choke off supplies of crude. When reports emerged last week of the air strikes on Sana’a as well as the southern port city of Aden which lies near the oil supply route through the Gulf of Aden and Suez Canal, prices of Brent crude went up by 4%.

Once it became clear there was no immediate threat the pressure on oil prices eased. Masaki Suematsu, manager of the energy team at brokerage Newedge Japan in Tokyo said, “Just because Saudi and others conducted air strikes doesn’t mean the oil market becomes suddenly tight.”

However, this is unlikely to be the end of it. Military analysts say the airstrikes are not able to stop the Houthi forces – which means the only way to end it is to develop a full-blown land invasion. Satellite imagery has shown large numbers of Saudi armour and artillery close to the border, but it could just be a bit of muscle flexing.

The problem is this is a land where internal tensions have been held for many years and the longer this conflict goes on the more likely it is the tinder box will ignite.  Saudi’s giant Ghawar oil field lies in the Eastern Province, home to an aggrieved Shia minority. Attacking Shia forces in Yemen will not go down well. That could have huge consequences for oil supply. “If the Saudis continue this war – and if they keep killing civilians – this is going to create internal instability in Saudi Arabia itself,” said Ali al-Ahmed from the Institute for Gulf Affairs in Washington.

For now, prices have returned to the below $50 per barrel mark, but Deutsche Bank’s Head of Commodities Michael Lewis says in the next few months things could start to improve on a more sustainable basis,  “We think the market could tighten in May or June as lower prices finally bite and the US stops adding supply. It could be an important inflexion point.”

Mamdouh Salameh looks beyond this year for an eventual return to high oil prices. It will take that time to get back up, but he believes we will see $100 per barrel again. “Remember that the major producers in the Arabian Gulf need an oil price of $100 to balance their economies. They cannot continue to spend their financial reserves waiting for the price to go up. They need a price like that. And I wouldn’t be surprised even if OPEC decides to reverse its wrong decision and cut production for a while to bolster the oil price.”