Kiplinger Energy Outlook: Oil Markets on Edge Amid Red Sea Attacks

Gasoline prices could shoot up if the Middle East situation worsens.

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So far, the attacks on shipping in the Red Sea by Houthi militants in Yemen have made global oil markets nervous, but haven’t caused a significant price spike. The Red Sea is a vital waterway for global commerce, including oil and gas traveling from the Middle East to the Suez Canal. The decision by many ship owners to route their vessels the long way around the southern tip of Africa to avoid potential missile and drone strikes adds considerable time and cost to any shipment, and thus could push up oil prices a bit. 

The real risk is that the current situation could escalate and cause bigger disruptions to waterborne energy shipments. Warships from the United States and other countries have been forced to police the Red Sea, shooting down Houthi missiles and drones, and more recently launching strikes on Houthi positions in Yemen. If these clashes worsen and draw in Iran, the Houthis’ chief backer, the huge oil shipments that pass through the Persian Gulf could become threatened. The Straight of Hormuz, the narrow opening into the Persian Gulf, is the most critical oil shipping route in the world, according to the U.S. Department of Energy. Roughly a fifth of the world’s oil flows through it each day, with massive oil tankers passing within a few miles of Iran’s coast. If it chooses to, Iran could effectively shut off that flow of oil by targeting tankers with its large arsenal of advanced antiship missiles.

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There’s no telling how the current conflict will evolve. But expect plenty of volatility in oil markets for the time being. And even without a major escalation, we think oil prices are likely to trend higher in the coming months. After dropping last autumn, benchmark West Texas Intermediate crude oil has stabilized in a range of $70 to $75 per barrel. Demand is seasonally weak now, but will pick up as spring approaches, as long as the U.S. economy stays healthy and consumers keep driving to jobs and for warm-weather vacations. U.S. oil production has grown enough recently to offset production cutbacks by OPEC and its allies. But if oil demand stays strong, it will be hard for American producers to keep meeting that demand without prices rising. So, we look for WTI to tick up to a range of $75 to $80 by late winter or early spring. If a wider war threatens in the Middle East, oil prices could go considerably higher.

Gasoline prices are holding steady, but they may have bottomed out for the winter. The national average price of regular unleaded is $3.07 per gallon, down a penny from a month ago. The price at the pump usually hits a low point in midwinter and then trends higher as spring nears. Demand starts rising with the mercury in thermometers, and refiners have to switch to costlier, summertime gas blends. So, we look for the national average price of regular unleaded to climb at least a little bit, maybe toward $3.25 per gallon by late winter.

Natural gas prices are volatile due to the ongoing severe cold outbreak across much of the United States. Demand soars during these cold snaps and supplies of gas in storage get drawn down, so traders bid up gas prices. However, it is hard to know when a cold pattern will relent and allow demand to return to normal, so gas prices can drop sharply if a weather forecast suggests a warming trend. The benchmark gas futures contract recently traded at $2.96 per million British thermal units. That’s down a lot from last week, but higher than gas prices were trading until a few weeks ago. If winter brings additional bouts of Arctic air in the coming weeks, we look for gas prices to push toward $3.50 per MMBtu or higher.  

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Jim Patterson
Managing Editor, The Kiplinger Letter

Jim joined Kiplinger in December 2010, covering energy and commodities markets, autos, environment and sports business for The Kiplinger Letter. He is now the managing editor of The Kiplinger Letter and The Kiplinger Tax Letter. He also frequently appears on radio and podcasts to discuss the outlook for gasoline prices and new car technologies. Prior to joining Kiplinger, he covered federal grant funding and congressional appropriations for Thompson Publishing Group, writing for a range of print and online publications. He holds a BA in history from the University of Rochester.