Introduction
There is now some consensus among oil market participants that the long-held assumption of a correlation of oil price to Middle East regional risk is broken. Since October 7, 2023, we have seen a consistent escalation in conflict, including an increase in the number of state and non-state actors engaged in the Israel-Gaza war, yet oil prices have remained in the range of $70 to $90 per barrel of Brent crude (with highs in October 2023 and after the April 2024 Iranian attack on Israel). However, high prices after a slight spike were never sustained and even quickly flattened during tense points of kinetic activity between parties of the conflict. The market has demonstrated a precise understanding of energy infrastructure risk rather than broader political risk, while sanguinity about the availability of supply, including from non-OPEC and North American production, continues to maintain price stability. The market has also likely absorbed an understanding of shifting demand, including the dynamics of China’s changing economy in its move away from infrastructure-centered growth and its demographic decline. Oil market participants understand that the devastation of communities in Gaza and Lebanon and direct strikes on both Israel and Iran have not severely affected the physical assets of oil and its transport and delivery. Despite threats from Houthi missiles and drones, oil shipments have found workarounds in longer transport routes, and both energy products and tradeable goods have been marginally affected.
Geopolitical Shifts
The larger takeaway from over a year of war is that the Middle East’s economy is fragmented, trade and investment are poorly integrated regionally, and the areas that have suffered the most are those with the least to offer in terms of exports and energy products. The Gazan economy was already isolated, so no contagion has occurred from its already weak trade or investment linkages. Israel’s gas exports to Egypt and its production in its offshore fields have remained resilient, and Israeli energy infrastructure remains intact. Lebanon has perhaps experienced the most damage in terms of growth and economic activity, but its mechanisms of protection were already degraded as social service delivery and state institutions were unprepared and incapable of responding to attacks on civilian and Hezbollah-linked infrastructure. The UNDP estimates that Lebanon will suffer a 9.2 percent loss of GDP this year. Egypt has suffered revenue losses of $6 billion per year due to decreased traffic in the Suez Canal. Without direct attacks on Iran’s oil refining or export infrastructure, heavy sanctions have not prevented Iran from meeting its customers’ needs in China and beyond. Iranian oil exports in 2024 stand at an estimated 1.7 million barrels per day (b/d). And despite threats of retribution for any collaboration or aid to US or Israeli military attacks on Iran, Saudi and Emirati oil production and export facilities have yet to face the risk of military strikes.
Beyond the impact of the ongoing instability in the Middle East, China’s economic transition from its government-supported construction boom to a strategy of upgrading its export value chain is contributing to the softness in oil prices. Many investors hoped that China’s economic stimulus measures would boost oil demand, but China’s oil demand has a lower sensitivity to macroeconomic support. How the Chinese government offers lending support to local governments in the form of debt issuance is still unclear, but a continued housing and construction boom, which previously fueled oil demand, is unlikely. The future pace and composition of Chinese economic growth may lead to a slower pace of oil demand growth. For example, some analysts estimate that China’s oil demand might only rise by 0.1 to 0.15 million b/d for every 1 percent gain in GDP growth. Over the past decade, the annual increase in Chinese oil demand has averaged more than 600,000 b/d, accounting for more than 60 percent of the total global average increase, according to IEA data. The IMF expects China’s economic growth to slow from 5.2 percent in 2023 to 4.8 percent this year and 4.5 percent in 2025.
As long as oil production, refining, and transport facilities within the Gulf are not attacked and Chinese demand remains sluggish, prices will remain flat in the $70 to $75 per barrel range, and OPEC and OPEC+ production cuts (at least for Saudi Arabia, Russia, Iraq, the UAE, Kuwait, Kazakhstan, Algeria, and Oman) will remain in place until the end of 2025 and beyond. Abundant spare capacity, especially within Saudi Arabia, provides a considerable cushion for price risk as well.
China and the Global Economy
The new geopolitics of energy and middle power hedging explains why China’s economic integration in the Middle East may be more important than regional conflict as a price and risk barometer. It also explains why the lack of economic integration of major Gulf producers with the wider Middle East has insulated them thus far from the war’s spillover effects. Since October 2023, the Middle East is still economically fragmented, but the region is more diplomatically engaged, both regionally and internationally. This engagement, particularly from the Gulf Cooperation Council (GCC) states with Iran and China, has complicated the United States’ position within the region and further segregated its support of Israel from its relations with Arab states. Arab states’ reliance on the United States for security support in the Red Sea and across the Arabian Peninsula is a necessity more than a choice, as there are few military alternatives to the United States but plenty of alternatives in trade and investment partnerships. The Gulf states are increasingly leaning toward Asia for energy product export markets and toward other emerging market economies, especially India, as partners in trade and investment. The US equity market will remain a strong magnet for Gulf and global investors, but these larger trendlines are pulling the Gulf away from the Middle East and Europe and more toward Central Asia, South Asia, and Africa.
The global economy continues to see not only fault lines in trade tensions between its giants China and the United States but also in North-South trade and investment more broadly. Within global trade, the share of South-South goods trade flows has exceeded all other directions of trade flows and continues to rise, according to analysis by Citigroup and UNCTAD. Moreover, opportunities have arisen for middle powers to play a larger role in facilitating trade and investment within and between Global South states. Even as foreign direct investment inflows into emerging markets have declined since the last peak in 2007, some structural changes are underway. Before the Global Financial Crisis of 2008, the globalization of supply chains was dominated by multinational companies based in the North, particularly Europe, the United States, and Japan. However, since 2014, emerging markets led by China and the GCC states have produced new global firms and sovereign investment vehicles that are driving South-South direct investment positions. The Gulf states and India are well-placed in this sense, particularly in trade and investment in energy products, to lead and integrate more South-South flows.
Conclusions
In the immediate term, stability in oil prices has resulted from plentiful supply and lack of direct threats to Middle East production facilities. These factors can change quickly, even as market participants are holding off on internalizing this risk. Structurally, the Middle East remains divided between oil and gas exporters and importers. And many of those exporters, notably Saudi Arabia and the UAE, have also diversified their political relationships to be closer to China, but more importantly, they are closer to their own export markets and partners in trade and investment. Geopolitical and economic shocks may test these new ties and mechanisms of trade and investment, however, especially if direct threats to China’s energy needs emerge.
As the Trump administration begins to govern, Gulf partners will call upon the United States for a show of protection, particularly if oil and gas production and export facilities come under threat of attack. Gulf oil exporters will also be watching closely as the Trump administration considers strengthening sanctions on Iran’s export capacity. The United States should communicate clearly and with prior warning to its Gulf partners about its intentions on its Iran policy. Doing so will help avoid a scenario in which GCC producers expect the supply of oil on the market to contract, only to see Iranian barrels continue to get to market. This policy would also help build trust and ultimately help stabilize prices. Moreover, the United States should avoid privileging one GCC state over another and feeding into regional divisions, especially as multiple GCC states host US military bases and forces. As trade tensions with China may increase with the implementation of tariffs in the Trump administration, the United States should be sensitive to how softening oil demand in China affects revenue streams for the GCC states. An American “win” against China could come at a price to the fiscal sustainability of the Gulf states, making American private investment and diversification support all the more valuable to Gulf partners.
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Dr. Karen E. Young is a Senior Research Scholar at Columbia University in the Center on Global Energy Policy. She was founding director of the Program on Economics and Energy at the Middle East Institute and remains a non-resident senior fellow.
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