Oil prices advance as Iran warship in Red Sea ups tensions

Brent and WTI advance as Iran deploys warship into Red Sea

Oil prices saw an uptick in New Year trading as tensions escalated in the Middle East with Iran deploying a warship into the Red Sea. The incident, coupled with an optimistic outlook for Chinese crude demand, propelled Brent crude up over 2% to nearly $79. The continuous contract for U.S. oil benchmark West Texas Intermediate (WTI) was also up over 2%, trading at $73.17.

The move comes after the U.S. Navy reported being fired upon while responding to a distress call in the Red Sea, marking the latest development in recent weeks along this crucial maritime corridor. Defense and shipping stocks also saw gains on Tuesday.

Houthi forces have been assaulting ships in the Red Sea since November, carrying out over 100 drone and missile attacks on vessels passing through the shipping corridor. The Yemeni rebel group, backed by Iran, has asserted that its attacks are specifically targeted at vessels associated with Israel, citing them as a response to the war in Gaza.

Incidents affecting merchant shipping in the region have prompted diversions of various vessels, impacting everything from container ships to gas carriers. Multiple firms, such as the UK-based oil giant BP and the oil tanker group Frontline, have diverted their vessels from the Red Sea in recent weeks as they continue to assess the situation.

The most recent oil-related impact occurred as two crude tankers diverted from loading in Sudan, although one was subsequently replaced by another vessel. Despite some companies and ship owners exercising caution, the broader impact on supply has, for now, been contained.

In the aftermath of the U.S. response to the attack on a Danish-owned container ship, the Maersk Hangzhou, a Houthi delegation met with officials in Tehran. On December 31, the U.S. Navy said it destroyed a number of Houthi “small boats” whose crew attempted to board a container ship in the Red Sea.

Following the incident, the Danish shipping and logistics giant Maersk once again suspended all Red Sea transit. The company had only resumed using the route a few days ago, after the U.S. and its allies launched a mission to safeguard ships in the area.

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Oil prices in 2024: Focus remains on geopolitics

Geopolitical factors are injecting fresh dynamics into the oil market, which saw its first decline since the COVID-19 pandemic in 2023. As 2024 begins, markets are focused on supply, given the counteraction of OPEC's output cuts by high production from the U.S. and other non-OPEC producers.

Further boosting oil's momentum is a substantial crude import quota from China, the world's largest buyer of the commodity. Private refiners and traders received an allocation for crude purchases almost matching last year's entire quota, potentially enhancing the country's consumption outlook.

Giovanni Staunovo, a commodity analyst at UBS Group, told Bloomberg on Tuesday:

“The latest events in the Red Sea, positive sentiment in European equity markets and the new Chinese import quotas are likely pushing crude higher”.

OPEC+ production cuts: Markets skeptical of implementation

The recent production cuts from OPEC and its allies are set to take effect this quarter, with extensions also possibly on the table. Traders are cautious regarding OPEC+'s November 30 commitment to further production cuts — they remain skeptical about its implementation.

The total production cuts account for 2.2 million barrels per day (bpd) from eight producers. This total includes the continuation of the voluntary cuts by Saudi Arabia and Russia, amounting to 1.3 million bpd.

Following the announcement of the OPEC+ decision in late November, J.P. Morgan analyst Christyan Malek told Reuters:

“The market reaction implies disbelief in the full efficacy of the cuts. However, setting a new framework for each member to deliver on its cut reflects the degree of trust and cohesion among the members; case in point, the fact Brazil is joining is testament to the strength in numbers for OPEC+”.

Oil price forecasts for 2024 have noted that oil and gas prices would likely remain elevated this year due to the geopolitical risks and hardening OPEC+ resolve.

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Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.