The prospect of a cataclysmic European tailspin is what economists call a left-side tail risk to prices: low in probability, but with the potential to topple the oil market should worldwide growth stall or even shrink. But right-side tail risk -- that oil markets might spike -- is also causing risk managers to lose sleep. The market's primary worry is an Israeli air strike on Iran, possibly with backing from or in coordination with the United States. If that happens, Tehran may well retaliate by disrupting tanker traffic in the Strait of Hormuz, the passage through which 35 percent of all traded seaborne oil flows. These are not idle fears. U.S.-led naval maneuvers in the Persian Gulf, which have included mine-sweeping drills, are already underway, and Iran has test fired missiles at ship-like targets near the Strait. Were Washington or its allies to launch a pre-emptive attack on Iran, oil prices would soar. Though Iran may be setting the stage for a confrontation, Western powers may end up being the ones to pull the trigger, setting off energy markets.
Even if such a conflict never materializes, efforts by the United States and the European Union to curb Iran's nuclear ambitions have already contributed to rising prices. Tightening U.S. sanctions and an EU ban on Iranian oil imports have caused the country's crude exports to fall to less than half of last year's average. This tightening of the screws has been disastrous for Iran, which depends on oil for 80 percent of its foreign revenue. By causing prices in the United States to rise, however, this strategy for bringing Tehran to the negotiating table has also been painful for American consumers. Whatever one thinks of the wisdom of sanctions in this or any other case, they have clearly caused global oil markets to labor under a strain that they would not have had to grapple with otherwise.
Still other wild cards remain far outside the control of OPEC. Market participants are already speculating about what measures Beijing will take to spur waning real economic growth. Oil has bounced along with other assets investors perceive as relatively risky, like emerging market equities, because of guessing about whether China might opt for more aggressive fiscal and monetary stimulus in the near future. Market fears persist about the possibility of a so-called Chinese "hard landing" and what it could mean for oil prices. Meanwhile, back in the United States, the much-discussed fiscal cliff looms. Its combination of tax hikes and spending sequestrations, due to drop in January if Congress fails to cut a deal, could weigh on domestic growth and hence oil demand. That loss could shave several percentage points off oil prices over the course of several years, according to a recent Citigroup analysis. Any mixed signals from Congress that cause Wall Street to question if or how it might tackle the approaching legislative deadline are sure to set off fireworks in the oil market in the meantime.
Make no mistake: Unrest in the Middle East has the potential to destabilize energy markets. With a civil war raging in Syria and North Africa in the midst of a trying transition period, it's not difficult to see how oil supplies could be interrupted. Trouble elsewhere in Africa, in places like the Sudan and Nigeria, is not helping matters. Given these realities, it's hard to imagine a scenario in which oil prices move significantly higher for an extended period absent something going wrong in that part of the world, which contains 70 percent of known oil reserves. Yet when it comes to sovereign decision-making, moves from Washington, Brussels, and Beijing may prove more unsettling to global energy markets in the months ahead than anything OPEC does.