Heightened tensions in the Middle East are keeping oil prices firm. The US WTI crude and the Asian benchmark Brent has gained about three percent so far during this week.
The already tight market conditions were deepened on concerns over supply disruptions from the Middle East amid conflict between US, Iran, Saudi Arabia, and other Gulf Arab states.
The Saudi Arabian oil tankers were attacked off the coast of UAE last weekend. The incident occurred at the world's most important oil transport waterway at Strait of Hormuz.
Almost 40 percent of the world's traded crude oil is transported through this shipping channel. Major Middle East oil exporters like Saudi Arabia, Iraq, Iran, Kuwait, Qatar, and Bahrain are using this waterway for oil transportation.
Vulnerabilities in the security of the key oil shipping passage raise concerns over exports from these countries.
In addition, two Saudi oil installations were hit by armed drones and the responsibility was claimed by Yemen's Houthi Rebels.
However, after the incident, the Saudi-led coalition carried out several air strikes in Houthi-held capital Sanaa, Yemen, on May 16 pushing the world's largest oil producing region into a war-like situation.
The US is also deployed warships and bombers to the Middle East to pressure Iran which is accused to aid the Houthi Rebels. The US pulled non-emergency staff from the American embassy in Baghdad on perceived threats from Iran.
The oil market has already been tightened due to ongoing OPEC plus supply cut, production decline from Iran and Venezuela and Russian outage due to Urals contamination. The tight market sentiments deepened further due to the likelihood of Middle East supply disruptions.
The US sanctions on Iran are pressurising the global oil markets. The US had imposed sanctions on Iran last November after unilaterally pulling out of a 2015 nuclear deal, in an attempt to further reduce Iranian oil exports. The US recently slapped sanctions on oil exports from Venezuela too, one of the largest oil producers and an OPEC member.
As per OPEC's latest monthly report, the producer group's output has declined in April due to a cut in production from Saudi Arabia and supply losses from Iran and Venezuela. Meanwhile, the group expects tight market condition and increased oil demand during this year.
The OPEC and non-OPEC oil exporters like Russia have cut oil production by 1.2 million barrels per day from January 1 for six months.
The group will meet in June to decide whether to extend the pact. It is expected that if OPEC sticks on with its April output numbers it would lead to an oil undersupply in the world market this year.
In the meantime, the output from the other top producers outside OPEC, like the US would keep the market well supplied. As per IEA, the booming oil output from the US would offset the shortage of exports from Iran and Venezuela.
In the first half of the year, US output was halted due to reduced rig counts and maintenance in the Gulf of Mexico but the agency expects higher output this year due to the uptick in drilling activity.
Looking ahead, escalating tensions in the Middle East are likely to push global oil prices higher. Meanwhile, slowing global economic growth would be a major headwind.
Increasing trade war tensions between the US and China is a threat to global economic growth and demand for oil. And oil traders are now worried about the supply tightness than the slumping demand.
(The author is Head Commodity Research, Geojit Financial Services)
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