THE ECONOMIST: What does the Israel, Iran conflict mean for the world’s oil prices?

For the past two years, the Middle East has been a tense place. Houthis have bombed commercial ships; Israel has begun full-blown military campaigns in Gaza and Lebanon; it and Iran have exchanged rockets. Yet oil markets remained calm, since the worst-case scenario — a full-blown war between Israel and Iran — had been avoided.

That scenario now appears alarmingly close. On the evening of June 12th, Israel launched dozens of air strikes on Iranian military and nuclear sites.

The attack threatens to inflame the Gulf, which pumps a third of the world’s oil. Brent crude, the global benchmark, rose by 8 per cent on June 13, to $US74 a barrel ($114). How high might it now go?

So far, no oil supply has been lost. Instead, higher prices reflect the possibility of future disruption. In October, when tensions last flared, a largely symbolic Iranian reaction allowed for de-escalation.

A similar outcome this time would see much of the risk premium evaporate, says Jorge León of Rystad Energy, a consultancy. Brent would probably then hover between $US65 and $US70.

That does not appear to be the most likely outcome, however. Benjamin Netanyahu, Israel’s prime minister, says strikes on Iran will continue for “as long as it takes”.

America’s president, Donald Trump, has warned that Israel’s next move could be “even more brutal”.

The cycle of strikes and retaliation could therefore last weeks. It might nevertheless stop short of an all-out war, in which case some Iranian oil supply would still be lost — perhaps 600,000 barrels a day (b/d) — as Western sanctions were toughened up. Since that only amounts to 0.6 per cent of global supply, price rises would probably be limited to $US5-10 a barrel.

The temperature would crank up another notch if Israel targets Iran’s oil wells and export terminals. Were Iran’s crude to be shut in, global supply would lose 1.7m b/d. Iran’s Gulf neighbours, the core of the Organisation for the Petroleum Exporting Countries (OPEC), have lots of idle wells.

Saudi Arabia and the United Arab Emirates alone have 3-4m b/d of spare capacity, which they could use in a crunch. It is not a given that they would, because doing so might be seen by Iran as collaboration with Israel, inviting retaliation.

They would also not mind prices rising, having tried (and failed) to push them up over much of the past two years. In such a situation, prices would rise in a linear fashion as Iran’s oil exports dwindled. They might hit a ceiling just below $US90 a barrel, as supply from OPEC and elsewhere became available.

The more aggressively Israel behaves, the greater the risk that Iran resorts to desperate measures. Among the most desperate would be to try to close the Strait of Hormuz, through which 30 per cent of the world’s seaborne crude and 20 per cent of liquid natural gas travel.

Even in the “Tanker War” of the 1980s, when Iran and Iraq fought and 239 oil tankers were bombed, shipments did not slow and prices stabilised after an initial spike. Iran would have to blockade the whole route.

That would be rash, not least because the narrow waterway, which links the Persian Gulf to the Indian Ocean, is vital to Iran itself. Moreover, both America (whose president wants oil prices to stay low) and China (which relies on oil imports from the Gulf) would probably send their navies to unblock the passage. Indeed, despite threatening such action several times, so far Iran has never dared take the risk.

Suppose, this time, it does. Saudi Arabia could divert some exports through its East-West pipeline, which has a capacity of 5m b/d, equivalent to about half of what the Kingdom produces.

But 85 per cent of Iraq’s exports, and all of those of Kuwait, Oman and Qatar, have no other route to market, meaning Brent might then rush past $US100 a barrel, says Michael Haigh of Société Générale, a bank.

And there is an even worse scenario. Many of the Gulf’s largest oil-production sites are within reach of Iranian missiles. Protecting them is just about impossible, especially in Saudi Arabia, since they are spread over enormous distances.

Were Iran to bomb them, prices might top $US120 a barrel, according to JPMorgan Chase, another bank. Across the region, risks are building. Global oil markets have just become a lot more flammable.