Assessing the Oil Market Volatility Caused by the Israel-Iran War

(GIUSEPPE CACACE/AFP via Getty Images)

An oil tanker is seen at Saudi Arabia’s port of Ras al-Khair.

Crude oil prices have been volatile amid the conflict between Israel, Iran and the United States, and the fragility of the ceasefire means that the risk of further escalation could drive prices higher and raise the threat of a global economic slowdown. Just around the time the United States struck Iranian nuclear sites on June 22 against the backdrop of the latest Israel-Iran military hostilities, oil prices increased as much as 15% compared to early June amid fears the crisis could disrupt supplies from the oil-rich Gulf region. However, prices have since returned to pre-crisis levels following Iran's decision to conduct a widely telegraphed, limited attack on a U.S. base in Qatar in response to the United States' June 22 strikes on Iranian nuclear facilities (which was broadly seen as a move meant to de-escalate the conflict), as well as the announcement of an Israel-Iran ceasefire that took effect on June 24. During the 12-day war, traditional global "safe haven" assets, including the dollar, U.S. treasuries and gold, did not see a significant surge, while U.S. equity markets have largely moved sideways over the past few weeks. These trends indicate that financial markets are primarily worried about the potential impact of Middle East instability on oil prices, given that other assets were not substantially affected.

On June 12, Israel began a sustained air assault on Iranian political and infrastructure targets, including facilities related to Iran's nuclear program. On June 21, the United States then bombed three major Iranian nuclear sites: Fordow, Isfahan, and Natanz. Iran responded with multiple attacks against Israel and, on June 23, Iran targeted a U.S. military base in Qatar with missiles.
Following the June 22 U.S. airstrikes on Iran, WTI crude oil prices briefly increased to above $75 per barrel, a five-month high, before retracing to $73.2 per barrel. Following Iran's symbolic retaliation for the U.S. strikes and the announcement of an Israel-Iran ceasefire, oil prices dropped 10% on June 24, reaching levels last seen just around the start of the conflict in mid-June.

The main reason oil markets were particularly impacted by the recent instability in the Middle East was the conflict's potential to disrupt oil supplies from the major Gulf producers. In the past, Iran and its proxies have targeted major Middle Eastern oil producers like Saudi Arabia and the United Arab Emirates. The latest crisis thus significantly impacted oil markets by fueling fears that Iran could again attack oil facilities and transport infrastructure in the crucial Gulf region, which accounts for roughly 40% of global oil production. Both Saudi Arabia and the Strait of Hormuz, in particular, are critical chokepoints for global oil and commodity flows. Saudi Arabia, the world's largest oil exporter and the country with the largest spare capacity to stabilize global oil prices, is especially vulnerable to Iran's missile attacks, given its proximity to the country and ties to the United States. And the Strait of Hormuz, through which approximately a quarter of the world's seaborne oil trade passes, could also become a target of Iranian retaliation through attacks on oil vessels or extensive mining. Against this backdrop, even an unsuccessful attempt by Iran to significantly disrupt Saudi oil production or impede oil trade through the Strait of Hormuz would still cause oil prices to rise.

The Gulf region is home to nearly 50% of the world's proven oil reserves. Saudi Arabia is the region's largest oil producer (as well as the world's largest oil exporter), accounting for 16.3% global crude oil exports in 2023, followed by the United Arab Emirates (9%), Iraq (8%), Kuwait (3%) and Oman (2%).
In 2023, Saudi Arabia exported 6.7 million barrels a day, while heavily sanctioned Iran exported 1.3 million barrels.

Despite the current ceasefire, the risk of renewed conflict remains, particularly as it remains unclear how much damage the United States and Israel's attacks inflicted on Iran's nuclear program. Barring a further escalation of the conflict, Iran is unlikely to attack oil tankers transiting the Strait of Hormuz or oil infrastructure in major Gulf producers (i.e., Saudi Arabia, the United Arab Emirates, Iraq, Kuwait or Oman). However, if Israel and/or the United States resume strikes on Iranian nuclear facilities, Iran could call on its proxies (e.g., Yemen's Houthis) to conduct such attacks aimed at disrupting regional oil supplies. But while they may cause prices to temporarily increase, such proxy attacks would unlikely cause sustained damage that interrupts regional oil supplies and shipping for a prolonged period, largely due to inevitable U.S. intervention. Conversely, if Iran decides to directly target Gulf oil infrastructure or tanker traffic in the Strait of Hormuz, oil prices would rise more significantly, potentially adding to global economic uncertainty if the Iranian attacks are sustained. That said, Iran's capacity to substantially disrupt shipping, beyond simply driving up insurance rates, remains in doubt, particularly given the United States and other countries' considerable naval assets in the region. Indeed, a direct military confrontation with the United States would immediately ensue if Iran were to use land-based or naval assets to attack tankers in the Strait of Hormuz — a risk that will very likely deter Iran from conducting such attacks. Furthermore, Iran has little interest in antagonizing other major powers like China and larger European countries, which would all suffer from a sustained increase in global oil prices. Following the 2019 Houthi attacks on Saudi Aramco facilities, Saudi Arabia has also enhanced protection of its vital oil sites, which will help mitigate the impact of potential future Iranian or Iran-backed attacks on the kingdom's oil production and exports. But despite these constraints, a worst-case scenario where Iranian retaliation takes a substantial amount of Gulf oil supplies offline still cannot be ruled out. Should this happen, strategic petroleum reserves held by countries like the United States, Japan, Korea and China could help cushion the initial supply shock, but heightened risk and uncertainty would nonetheless likely lead to a significant spike in oil prices.

Iran could also seek to increase mining activities in the Strait of Hormuz to disrupt maritime traffic, which may be more effective given the limited number of mine countermeasures vessels capable of clearing mines available to the United States and its allies, like the United Kingdom.
The International Energy Agency currently estimates that global spare oil capacity stands at 5.3 million barrels per day. Of this, Saudi Arabia accounts for 3.1 million barrels, and the United Arab Emirates accounts for another 0.4 million barrels.
The Strait of Hormuz is a critical chokepoint for global trade. Each day, roughly 20% of the world's oil consumption — along with nearly 30% of mineral trade and 15% each of fertilizer and chemical trade — passes through the strait.

A sustained spike in oil prices driven by renewed military hostilities between Israel, Iran and the United States would significantly heighten the risk of a global economic slowdown, amplify U.S. monetary policy uncertainty, and disproportionately impact emerging and developing economies. A sharp and sustained surge in oil prices caused by instability in the Middle East would risk tangibly slowing down both the U.S. and global economies. In the United States, this would further complicate the Federal Reserve's efforts to address rising inflation and decelerating economic activity in the wake of U.S. President Donald Trump's sweeping tariffs. The added uncertainty about the short-term path of U.S. interest rates would, in turn, only exacerbate global economic uncertainty. Any hesitation by U.S. central bank to lower interest rates in the face of higher oil prices and an impending economic slowdown would also anger Trump, which would only further spook investors and increase financial uncertainty — especially if it leads to Trump escalating his threats to replace Fed Chair Jerome Powell. A sustained, outsized increase in oil prices would also disproportionately harm vulnerable emerging and developing economies due to their weaker macroeconomic fundamentals and reduced capacity to respond to external shocks.

A rule of thumb, backed up by research, suggests that a $10 increase in global oil prices typically reduces U.S. economic growth by 0.1-0.3% and raises consumer price inflation by 0.2-0.4% in the following year. This means an oil price increase to $130, last seen in May 2022 during the post-COVID recovery, has the potential to reduce U.S. growth to nil, as the International Monetary Fund (IMF) currently expects U.S. GDP growth to average 1.8% in 2025.
With the exception of the 1970s oil shock, geopolitically driven oil price spikes have generally proven manageable and short-lived in recent decades, as seen during the 1980s tanker wars and the 1991 and 2003 wars in Iraq. However, in its latest Global Financial Stability Report, the IMF found that while geopolitical risk events typically have a minor impact on global asset prices, major events like extended military conflicts can significantly drop stock prices and increase sovereign risk premiums, especially in emerging markets.