Oil price outlook: Israel is in ‘three eyes for one eye’ mode

Following the barrage of missiles Tehran launched at Israel earlier this week in retaliation for the killing of Hezbollah leader Hassan Nasrallah in an Israeli airstrike in Lebanon, expectations are high that Iran’s oil sector could be targeted next.

As a result, Brent crude oil prices jumped 8% over the past week, settling at $78.05 a barrel on Friday. But that’s well below the spike above $120 a barrel in early 2022 after Russia invaded Ukraine as well as the $94 peak reached after Hamas attacked Israel a year ago.

Bob McNally, founder of Rapidan Energy Group and a former energy adviser to President George W. Bush, said oil markets won’t take notice until physical supplies actually come offline.

“It’s ‘boy who cried wolf,’ and they’re tired of it, and I think they’re hoping and expecting perhaps Israel will be restrained in its response and that we won’t see a material disruption in the energy production and flows,” he told CNBC on Wednesday.

But the wave of airstrikes Israel launched last weekend on Houthi targets in Yemen, where repeated attacks on Israel have originated, could be an indicator of whether it will actually show such restraint.

“Israel is in three eyes for one eye mode here,” he added.

Still, McNally expects Israel will initially hit air defenses, munitions supplies, or command and control centers. Such targets could help soften the battle space if Israel chooses to hit Iran again in a future strike, he explained.

But hitting Iran’s nuclear complex or major oil facilities would trigger a regional war and send oil prices sharply higher, he warned.

“I’ll be a little surprised if they throw that big a roundhouse punch here in the first retaliatory package,” McNally said.

A critical piece of Iran’s oil infrastructure is Kharg Island, which handles 90% of the country’s crude exports, according to Helima Croft, head of commodity strategy at RBC Capital Markets.

If Israel hits that facility, then Brent crude would likely soar above $90 a barrel, she told CNBC on Friday, as a strike on such an important terminal could impact 1.7 million barrels a day in exports.

Fearing a potential attack, empty oil tankers that were approaching Kharg Island to fill up earlier this week, instead turned around and fled, according to TankerTrackers.com.

Alternatively, Israel could hit an oil refinery, which would have a lesser effect on global crude supplies than an export hub would, Croft said.

For its part, Tehran has warned that it could attack Israel’s energy infrastructure, such as power stations, refineries and natural gas fields. But a blockade of the Strait of Hormuz, which is considered the world’s most important chokepoint, is seen as less likely because it would also hurt Iran’s own oil shipments.

“The risk is that it’s no longer a limited conflict between Israel and Iran. There’s now a wide arc of uncertainty,” energy guru Daniel Yergin, who is vice chairman of S&P Global, told the Financial Times. “There may be tits for tats. The danger is the tits and the tats could get a lot bigger.”