Why the Oil Market Is Not Shocked
5 min read
About a month ago, I was greeted by a welcome sight at the gas station in Connecticut where I usually fill my tank: the price of regular had fallen below $3 a gallon. In the weeks that followed, however, the Middle East was racked by escalating conflict. Israel—which was already in the middle of a nearly year-long invasion of Gaza—assassinated the Hezbollah leader Hassan Nasrallah with an air strike in Beirut. Iran responded by launching a missile attack on Israel, and Hezbollah fired salvos of rockets. Israel then invaded southern Lebanon, and the Biden administration urged restraint as the Israeli government reportedly weighed a retaliatory attack on Iran’s oil fields.
In sum, the past few weeks have been as tense and belligerent a time in the Middle East as we’ve seen in many years. And yet, when I filled up my tank again yesterday, the price of a gallon of gas was only $2.94.
Once upon a time, this would have been surprising: Geopolitical turmoil, particularly in the Middle East, used to send oil prices soaring, as frantic traders—anticipating potential supply shortages—added what’s often called a “war premium” to the price of crude. This time around, oil prices rose only mildly—at their peak, in early October, they were up about 10 percent from recent lows—and they’ve now fallen back to about where they were a month ago. Prices at the pump, meanwhile, barely budged through all the chaos. Some of this reflects the fact that a direct conflict between Israel and Iran is still at more of a simmer than a full boil. But the oil market has also responded calmly to the clear risk of wider war because fundamental changes in global energy markets over the past 15 years have made the world’s economies—including, above all, the United States’—much less vulnerable to Middle Eastern tumult.
The most obvious, and important, of those changes is the huge boom in U.S. oil production, as the technology of “fracking”—hydraulic fracturing and horizontal drilling—has allowed the mass production of “tight oil” (so called because it’s contained in impermeable shale or sandstone). U.S. production of tight oil has risen roughly eightfold since 2010, and the country is now the world’s largest oil producer, pumping more than 13 million barrels a day—a record arrived at under the Biden administration, despite its on-paper commitment to a shift away from fossil-fuel energy.
That flood of new supply has made the production of a country such as Iran less important to the world oil market: Iranian exports are now only about 2 percent of total global production. It has also forced OPEC+, the oil cartel that includes the old, predominantly Middle Eastern members of OPEC as well as major producers such as Russia and Mexico, to cut back on its members’ production in an effort to keep prices high. As a result, OPEC+ members have a great deal of spare capacity: Estimates suggest that they could produce 5 million more barrels a day than they’re currently pumping. So even if, say, Iranian oil exports were curtailed by a full-blown war with Israel, OPEC+ members could make up for it with ease.
The boom in U.S. oil production has also made it harder for countries like Iran to use oil as a geopolitical weapon. Conflict with Iran always raises the possibility that Tehran might try to close the Strait of Hormuz, a key waterway for oil tankers that runs between Iran and the United Arab Emirates. But because America imports less oil than it once did, these days closing the strait would have less impact on the U.S. than on Iran—and would hurt the main buyer of Iran’s oil, China.
Additional factors have also helped mute the oil market’s response to crisis. Over time, American policy makers have become more willing to use the country’s Strategic Petroleum Reserve to soften any blow to consumers: Barack Obama used the reserve in 2011, when Libyan oil production went offline, and Joe Biden used it in 2022, after Russia’s invasion of Ukraine. The strategic reserve currently holds 383 million barrels of oil, so replacing Iran’s supply would not be a challenge.
Meanwhile, economic growth, especially in China, is not necessarily translating into demand for oil the way it once did. The boom in renewables for energy generation has, on the margins, reduced oil dependence, as has the fact that all-electric and hybrid cars now account, in the U.S., for almost 20 percent of the “light-duty vehicle” (essentially, passenger cars) market, and likely a larger percentage of equivalent sales in China. If anything, oil traders today are concerned about softness in demand for oil from China, because Chinese growth rates have cooled dramatically in recent years.
Oil traders themselves may be less prone to alarm when a geopolitical crisis blows up because recent history suggests that an overwrought response—such as panic-buying that pushes up prices sharply—is rarely justified. In 2019, when a Houthi drone attack on oil facilities in Saudi Arabia shut down half the country’s oil production, prices spiked by almost 15 percent. But after the Saudis released oil from their reserves and got production back online in a matter of weeks, prices quickly tumbled. Similarly, in 2022, when Russia invaded Ukraine, prices surged because of fears of what Western sanctions might do to Russian oil production. But in less than two months, the cost of a barrel was back to where it had been before the invasion. What traders have learned, in other words, is that betting on oil prices spiking and staying high because of geopolitical tension is likely a bad wager.
If Israel does decide to bomb Iran, oil prices are still almost certain to jump. But the oil market would adapt and respond to that event in a way that would minimize its impact on global prices. And because traders understand this altered dynamic of the market, they seem to be acting quite differently toward this risk than they once did. It is possible, of course, that the oil market has become excessively complacent. But what seems more likely is that resilience, in a sense, breeds resilience: Because traders are confident that the market will be able to deal with conflict, they’re more likely to assess risk in a coolheaded fashion, rather than a panicky one. Which is why many of us are still paying only about $3 for a gallon of gas.
