Changes in the situation in the Middle East have become the focus of attention in global capital markets. The market is worried that this development may have an impact on crude oil production, thereby further driving up international crude oil prices.

On April 14, the team led by Goldman Sachs commodity analyst Daan Struyven pointed out in the report that the geographical situation in the Middle East continues to be unstable. The short-term trend of oil prices will depend on how investors, producers, and consumers assess future risks. The key is Israel's next move, which will determine the prospects for oil supply in the Middle East region.

Goldman Sachs pointed out in the report that, on the one hand, the market has reason to believe that this geo-risk incident has temporarily cooled down, and the market response may be relatively limited. Judging from Iran's current attitude, it is more cautious. It is necessary not only to prevent Israel from taking further retaliatory actions, but also to avoid escalating military action. This is consistent with the public statements made by Iranian officials.

However, on the other hand, Goldman Sachs believes that this is the first time that Iran has directly attacked mainland Israel, and there is still great uncertainty about the subsequent geopolitical situation. If the market prices the possibility of a decrease in Iran's supply is higher, then it may lead to a higher geopolitical risk premium. According to preliminary calculations, as of last Friday, the price of crude oil already included a geopolitical risk premium of 5-10 US dollars/barrel.

Goldman Sachs said that although the possibility of oil supply interruptions in the Strait of Hormuz is still very low, if oil transportation from the Strait of Hormuz, which currently accounts for 17% of global oil production, is blocked, oil prices will rise 20% in the first month, and if the interruption continues for several months, oil prices may double.

Entering 2024, international oil prices have continued to rise. Last week, the global benchmark Brent crude oil once broke through 92 US dollars/barrel and jumped to the highest level since October last year. As of press release, the price of Brent crude oil futures fluctuated slightly, at $90.21 per barrel, with an increase of 17% since the beginning of 2024.

Oil prices face upward risks

Goldman Sachs pointed out in the report that in the short term, how the market assesses the future risk of oil supply will determine oil prices. From a medium-term fundamental perspective, the impact of geopolitical events on oil prices ultimately depends on the impact on oil supply, demand, and inventories. The key still lies in OPEC+'s production policy:

The outlook for oil prices in the short term depends on whether the market reassesses the risk of oil sanctions against Iran. Since taking office in 2021, US President Joe Biden has relaxed sanctions on Iranian oil exports. It is estimated that Iran's crude oil production has increased by about 600,000 b/d (more than 20%) in the past two years. If the market prices the possibility of reduced supply to Iran more, then this could result in a higher geopolitical risk premium.

In the medium to long term, geopolitical factors impeding OPEC+'s ability or willingness to use backup production capacity will be the main risk of rising oil prices.

Our basic forecast assumes that there will be no supply disruptions in the future and that OPEC+ will gradually increase production starting in the third quarter, with high backup capacity. The OPEC+ forecast model shows that the recent increase in futures spreads and speculative positions has increased the possibility that eight countries, including Saudi Arabia, will increase production this year. If supply is interrupted in other places (such as Iran), the possibility that these eight oil-producing countries will increase production may rise further.

Goldman Sachs believes that although the geopolitical risk premium (compensation required by investors for the risk that geopolitical shocks may reduce oil supply) is difficult to accurately determine, based on the pricing framework and hedging costs, the current price is roughly estimated to include a premium of about 5-10 US dollars/barrel, which means that the market believes that the supply will decrease by 4 million b/d within the next 12 months or 8 million b/d within the next 6 months is 15%, and the baseline scenario probability of uninterrupted supply is 85%:

Following the fact that the price of Brent crude oil has just broken through $90 per barrel and that the International Energy Agency (IEA) released higher-than-expected inventory data on Friday, our pricing framework shows that the difference between the 1-month futures price of Brent crude oil and the 36-month futures price (that is, the 1/36 difference) is about $10 per barrel higher than the model forecast.

We believe that geopolitical downside supply risks explain most, but not all, of the $10 per barrel gap between actual and predicted spreads. What needs to be clarified is that the fair value of the spread depends not only on the inventory level, but also on the inventory risk surrounding crude oil. A more comprehensive probabilistic model shows that when the downside risk of supply increases, the spread will increase.

Goldman Sachs predicts that Iran's crude oil production has risen to about 3.4 million b/d (accounting for 3.3% of global supply), increasing by about 600,000 b/d over the past two years. The four largest OPEC oil producers in the Middle East produced a total of 18.7 million b/d of crude oil in the first quarter. The global backup capacity is expected to be close to 6 million b/d:

We estimate that global backup capacity is close to 6 million b/d, with the largest concentrated contributions coming from Saudi Arabia (2.5 million b/d), the United Arab Emirates (1 million b/d), and Kuwait (500,000 b/d).

Considering the current outlook for the crude oil market, Goldman Sachs said it is still concerned about the following 4 potential risks:

1. Tensions between the US and several major OPEC+ oil producers are intensifying, and OPEC+ may further expand production cuts.

2. Geopolitical conflicts may damage upstream, midstream, or downstream oil infrastructure.

3. Iran's crude oil supply may decline due to disruptions in oil supply or a tougher stance by the US government.

4. Although the possibility of oil supply interruptions in the Strait of Hormuz is still very low, if oil transportation from the Strait of Hormuz, which currently accounts for 17% of global oil production, is blocked, oil prices will rise 20% in the first month. If the interruption continues for several months, oil prices may double.

The pricing framework indicates that a one-month interruption in supply of 1 million b/d will cause the price of Brent crude oil to rise by about $1 per barrel. As the market needs to price all of these possibilities, oil prices are likely to jump.

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