Resurgence of Conflict in the Middle East: Where Does Oil Demand Go from Here?

A year ago, the Israel-Palestine conflict had just erupted, significantly impacting the oil market and pushed prices higher. Today, oil is more than just fuel powering our daily lives - it's a barometer of global economic health and a key player in the global financial markets. As its price rises and falls, it sends ripples across markets, shaping everything from energy stocks to currencies. Understanding oil's influence can open doors to investment opportunities in a volatile, yet rewarding landscape.

In previous two articles, we primarily discussed the oil supply side. In this article, we will shift our focus to the changes in global oil demand, discovering how actual demand influences oil market trends and price volatility.

Industry

As one of the most affordable, convenient, and essential energy sources discovered by humanity in nearly 200 years, oil has a wide range of applications and serves as a cornerstone of modern societal development. The transportation sector's reliance on oil is particularly evident, accounting for 44.57% of total oil demand. Additionally, oil is fundamental to various industries, playing a critical role in electricity generation and the production of chemical products in the petrochemical sector, such as plastics, fertilizers, and synthetic rubber. Oil is vital to the global industrial system and to the economic development of all countries.

Changes in Oil Supply and Demand

When global economic growth slows down, particularly when industrial and manufacturing activities weaken, oil demand typically decreases accordingly. A reduction in manufacturing activity signifies a lower demand for oil in machinery operations, fuel production, and the manufacturing of chemical products, thereby directly impacting the oil market. Additionally, as industrial activity declines, transportation demand also decreases, further suppressing oil demand. Moreover, a slowdown in economic growth may diminish consumers' purchasing power, affecting daily commuting and travel activities, which indirectly leads to a reduction in oil consumption. The following chart illustrates the positive correlation between GDP and oil prices, showing that when economic conditions worsen, oil prices tend to decrease due to a decline in demand.

In the following chart, the positive correlation between diesel consumption and the Manufacturing Purchasing Managers' Index (PMI) is shown, with the PMI serving as an indicator of manufacturing economic trends. This indicates that as manufacturing activity improves, the demand for diesel consumption also rises.

In the Short-Term Energy Outlook report published by the U.S. Energy Information Administration (EIA) in October 2024, it was noted that due to weak expectations for industrial production and manufacturing growth in the United States and Canada, oil consumption forecasts for OECD countries in 2025 have been revised downward. Despite the slowdown in demand, OPEC+ production cut policies continue to create a global oil supply deficit, leading to a persistent decline in inventories. Additionally, the high level of geopolitical uncertainty in the Middle East exacerbates the instability of oil supply. As a result, barring any significant changes, the EIA predicts that oil prices are likely to remain elevated until the second half of 2025.

Oil and Recent Geopolitical Event

Since its discovery and widespread application, oil has never been regarded merely as a common energy source. After World War II, oil became closely tied to the U.S. dollar, transforming it into both a catalyst for conflict and a tool of political manoeuvring, with impacts that extend beyond basic supply and demand dynamics. For example, recent escalating tensions in the Middle East have driven oil prices higher. Following comments by U.S. President Joe Biden regarding potential attacks on Iranian oil infrastructure, both WTI and Brent surged by over 9% over the weekend.

Implication of Oil to the Financial Markets

We have discussed how oil prices are closely related to global demand and geopolitical events, but what do movements in oil prices actually tell us? Let’s dig into it.

Although oil is a common commodity in our daily lives, its price also serves as a critical financial market signal, influencing the performance of various asset classes. Market participants closely monitor oil prices because they impact sectors ranging from energy to transportation, shaping broader economic and investment decisions. Here are a few key implications of movements in the oil market.

1.        Airlines - A Costly Relationship

Airline stocks often have an inverse correlation with oil prices due to the significant role fuel plays in their cost structures. As oil prices rise, airlines face higher operating expenses, which can squeeze profit margins. This squeeze leads to reduced earnings potential and can drive stock prices lower. In periods of oil price surges, airlines usually struggle to maintain profitability, forcing them to cut costs or raise ticket prices, which a negative news for consumers, and eventually impact demand and investor sentiment. Thus, the fortunes of airline stocks are often at the mercy of fluctuating oil markets, creating a cyclical tension between the two. The chart is showing the WTI oils vs the 3 largest airlines in the US.

2.        Gold - Opposite Ends of Investor Sentiment

Gold, as we previous discussed, a classic safe-haven asset, frequently moves in the opposite direction of oil. When oil prices drop, it is actually signalling potential economic slowdowns or deflationary pressures, investors often flock to gold to preserve value, driving its price upward. Lower oil prices can indicate weaker global demand and financial uncertainty, which heightens the appeal of gold as a stable store of wealth. In contrast, when oil prices rise, you can imagine the economic has grew, yet it may reduce gold’s allure, pushing down its price as riskier assets gains. This reverse relationship highlights the contrasting roles gold and oil play in reflecting market confidence.

3.        Energy Stocks - A Symbiotic Relationship

Energy stocks, particularly those in the oil and gas sector, having a strong positive correlation with oil prices. When oil prices rise, the profitability of companies involved in exploration, production, and refining increases, driving up their stock values. Higher oil prices usually translate to improved margins and cash flow, leading to investor optimism and stock price appreciation for energy companies. Conversely, when oil prices decline, these companies may face shrinking revenues and reduced profitability, which negatively affects their stock performance. This kind of close alignment makes energy stocks highly sensitive to the ebbs and flows of the oil market. Below chart is showing the relationship between WTI oil and the 2 largest oil producers in the US.

Oil Future Position

Due to the non-renewable nature of oil, humanity has been actively seeking alternatives or substitute solutions in anticipation of a future energy transition following potential oil shortages. Recent advancements in this process have had a notable impact on the overall demand for oil.

As the energy transition accelerates, it is expected that the growth momentum of oil demand will weaken between 2022 and 2028. According to predictions from the International Energy Agency (IEA), the consumption of automotive fuel is projected to peak in 2023, while other forms of transportation fuel are anticipated to reach their peak in 2026. Several factors are expected to slow the annual growth of transportation fuel demand, including the implementation of stricter energy efficiency standards, the accelerated adoption of electric vehicles (EVs), and structural changes in the global economy.

Conclusion:

In conclusion, oil's close relationship with global demand and geopolitical issues makes it one of the most volatile commodities in the market. While this volatility can create uncertainty, it also presents opportunities for investors to capitalize on price fluctuations across different asset classes. From energy stocks and currencies to safe-haven assets like gold, the movement in oil prices serves as a key market signal, offering a wide range of investment possibilities. By understanding the dynamics behind oil's price changes, investors can position themselves to take advantage of shifts in the global economy and geopolitical landscape.

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