Stuff Happens — War Makes Being Brave on Oil Risky
As Iran and the US trade rhetoric over the conflict in Gaza, there is some alignment, but that’s no justification for too much market bravery on crude oil.
The United Nations General Assembly gathered for an Oct. 27 vote in New York on an "humanitarian truce" amid the Israel-Hamas war.
Photographer: Andrea Renault/AFP via Getty Images
I instinctively fill up my car whenever war breaks out in the Middle East, yet it appears my better-safe-than-sorry anxiety is premature. Nearly a month after Hamas attacked Israel, oil prices have barely inched higher.
The reason? For now, despite ample rhetoric on both sides, Tehran and Washington are trying to prevent an energy crisis on top of the diplomatic one.
Let me emphasize “trying” and “for now” here. As oil trading throughout this geopolitical crisis continues, one should remember former UK Prime Minister Harold Macmillan’s warning: “Events, dear boy, events.”
As a whole, oil traders seem relaxed. Brent crude, the global benchmark, closed at $84.58 a barrel on Oct. 6, the day before Hamas militants attacked Israel in a surprise dawn raid, killing more than 1,000 people and taking hundreds of hostages. Almost a month later, with several thousands more killed on the Palestinian side amid Israel’s fierce retaliation, Brent is only slightly elevated. On Wednesday this week, it changed hands at just above $85.
But what about the options market, the arena where tail risk is priced? Shortly after the attack, the so-called put-call option skew turned bullish as traders priced in the risk of a spike. Since then, the skew has given up most of its gains. Tellingly, the open interest on the call option contract that would profit from oil rising to $100, $110 and $115 over the next three weeks has declined the past couple of days, after more than doubling since October. That’s perplexing. The likelihood of a wider regional war may be far-fetched, but its impact would be severe. In market parlance: The tail is rather fat. It does feel like the options market is a bit too sanguine.
The Hamas strike came on the eve of the 50th anniversary of the world’s first oil crisis, and the parallels between October 1973 and October 2023 were easy to draw. But as I warned in my tentative reaction after the attack, the resemblance ended quickly. The main upside risk for oil prices — both a month ago and now — is if the war directly engulfs Iran.
For as much as Iran’s proxy groups are harassing Israeli and US troops, Tehran doesn’t seem in a hurry to enter a regional war. Nor is Washington rushing to strictly enforce its longstanding oil sanctions on the Islamic Republic, a move that would reduce global oil supply going into 2024. In the eyes of bearish oil traders, each day that passes without a broadened conflict is another day that the threat recedes.