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Crude oil futures fell Monday, as traders awaited Israel's response to Iran's weekend missile and drone attack that caused little damage, but investors worry that the breadth of the assault may leave Israel with no choice but to retaliate.
Israel's military chief Lt. Gen. Herzi Halevi said his country would respond to Iran's strike, but did not say when or how.
"The outlook for oil seems to hinge on Israeli response to the attack," J.P. Morgan analysts including Natasha Kaneva said, and "with bellicose rhetoric coming from both sides, markets might continue to place a sizable premium on the price of oil in the immediate term."
Noting the assault is the first time that Iran has directly hit Israel from Iranian territory, JPM analysts said the "dramatic departure for Tehran, which until now has preferred to operate through proxies, [could] potentially rewrite the rules of engagement between the two countries and could trigger an Israeli response that threatens a full-scale regional war."
Following the attack, Citi analysts raised their short-term oil price forecast to $88/bbl from $80 on the higher risk premium, but it believes the current market has not sufficiently priced in a potential continuation of an all-out conflict between Iran and Israel that could push oil to $100/bbl, while any de-escalation could see prices dropping to the high $70s or low $80s.
Societe Generale hiked its Q2 forecast for Brent crude to $91/bbl and WTI to $87.50/bbl, saying it expects geopolitical risk will become embedded in prices for the foreseeable future.
"We still view direct U.S.-Iran military action as a tail risk, its probability has increased from 5% to 15% with crude prices under such a scenario easily spiking above $140," SocGen said.
Front-month Nymex crude (CL1:COM) for May delivery closed -0.3% to $85.41/bbl, while front-month June Brent crude (CO1:COM) ended -0.4% to $90.10/bbl.
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Oil benchmarks had gained on Friday in anticipation of Iran's attack, with prices soaring to their highest since October.
The Biden administration likely will tap oil from the U.S. Strategic Reserve as fuel demand is expected to hit a new post-pandemic high with millions of Americans preparing to hit the roads this coming summer, when demand peaks, Macquarie oil and gas strategist Vikas Dwivedi told Bloomberg.
"The government will have to release oil from the SPR with a lot of aggressiveness to tame prices," Dwivedi said, adding "there are not many tools available and this is one of the most effective."
RBOB gasoline prices have surged by nearly a third YTD alongside a rally in crude oil prices, yet demand is expected to rise while fuelmaking may fall short of expectations as years of delayed maintenance by refiners could lead to breakdowns, Dwivedi said.