Oil prices jumped last week after Iran struck Israel in a missile attack, raising the prospect of possible disruptions to supplies of crude from the Middle East.

While there’s been persistent geopolitical turmoil, with wars in Ukraine and the Middle East, the physical supply of oil hasn’t been impeded, says Goldman Sachs Research’s Daan Struyven in an episode of Goldman Sachs Exchanges.

The big question for investors is whether further escalation in the conflict in the Middle East is going to lead to a reduction in supply from Iran, says Struyven, co-head of commodities research in Goldman Sachs Research. Big oil producers have a lot of spare capacity available, but much will depend on the severity of any disruption to oil supply from Iran and whether, and how quickly, other major producers ramp up production.

How much could oil prices rise in a supply disruption?

Goldman Sachs Research forecasts Brent crude oil will trade in a range of $70-85 per barrel, with an average price of $77 in the fourth quarter and $76 next year, assuming there’s not a major supply disruption. Struyven’s team estimated the potential impact of two hypothetical scenarios of curtailed oil supply:

Assuming a 2 million barrel-per-day disruption to Iran supply for six months, Brent could temporarily rise to a peak of $90 if OPEC producers rapidly offset the shortfall. Prices could peak in the mid $90s next year without an OPEC offset.

Assuming a 1 million barrel-per-day persistent disruption to Iran supply, reflecting for instance a tightening in sanctions enforcement, Brent could reach a peak in the mid $80s if OPEC gradually offsets the shortfall, and a 2025 peak in the mid $90s without an OPEC offset.

Historically when there’s been an oil supply disruption in the Middle East, Saudi Arabia and the United Arab Emirates, which have combined spare capacity of more than 4 million barrels, have offset about 80% of lost supply within two quarters. “So that will be a key thing to watch if we were to see actual disruptions,” Struyven says.

Typically the core OPEC countries, such as the UAE and Saudi Arabia, step in when there’s a dislocation in oil production — but with a lag. The rising production from OPEC+ tends to be slower than the drop in supply due to the disruption. “So it probably mean a tighter market and higher prices until the market rebalances eventually,” Struyven says.

And while the US is now the largest oil producer, accounting for roughly 20% of global supply, much of the spare capacity, or insurance against supply disruptions, “is very much concentrated in the Middle East,” he says. The UAE, Saudi Arabia, and Kuwait together account for about 80% of spare capacity.

“So the key question is, if we see escalation, will they be able to get the barrels to the market? And second, will they be willing to bring the barrels back to the market?” Struyven adds.

Will demand from China increase oil prices?

When it comes to oil demand, is there scope for China’s recent economic stimulus to change the balance relative to supply?

“Not so much,” Struyven says. Even as China was the main driver of oil demand growth in the five or 10 years before the pandemic, the US remains the largest consumer of oil. The upside demand from China’s recent stimulus measures, meanwhile, appears relatively limited. High frequency data on Chinese demand are soft, and our economists forecast that the package discussed so far would boost GDP growth by only about 40 basis points.

If Chinese policymakers were to implement other measures to support the economy, they could be designed to accelerate the country’s shift away from oil, for example, by increasing the build out of charging infrastructure for electric vehicles.

Oil demand from other countries, however, could be stronger. “Over the last couple of years, oil demand has surprised to the upside, especially in the US but also in places like India,” Struyven says. Interest rate cuts by the US Federal Reserve may support demand in the US and abroad, especially if those cuts lead to a cheaper US dollar, which could help lower the cost of oil products outside the US.

“The trend for oil demand growth in developed markets is now negative, because of energy efficiency gains and the rollout of EVs,” Struyven says. “But we forecast positive oil demand growth, both in the US and the OECD more broadly, precisely because we have above consensus, above trend US GDP forecasts.”

Source: Goldman Sachs