War, or even the threat of war, can significantly impact oil prices for several reasons:
- Supply Disruptions: Many of the world’s largest oil reserves are located in regions that have historically been prone to geopolitical tensions or conflicts. War can halt production or disrupt transportation routes, making it difficult or impossible to get oil from extraction points to the global market.
- Safety Concerns: War can endanger the physical infrastructure needed for oil production, such as pipelines, refineries, and shipping facilities. This can lead to decreased production, which can result in increased prices due to a supply shortage.
- Speculation: The oil market is not just influenced by current supply and demand, but also by traders’ expectations of future supply and demand. If traders believe that a war will reduce oil supplies in the future, they may buy oil futures contracts now, driving up prices in the present.
- Stockpiling: In anticipation of prolonged conflict and potential supply disruptions, countries and companies might increase their reserves of oil, leading to a spike in demand and consequently, higher prices.
- Economic Uncertainty: Wars introduce a lot of economic uncertainty, which can affect currency values, particularly of the U.S. dollar, which is the primary currency used in oil transactions globally. A weaker dollar can lead to higher oil prices.
- Strategic Targeting: Oil facilities might be targeted either because they are of strategic importance or as a means of economic warfare to cripple the adversary’s economy. Such targeting can reduce the oil supply, leading to increased prices.
- Increased Consumption: Military operations require fuel. A country at war, especially a major power, can significantly increase its consumption of oil, leading to increased demand.
- Trade Embargoes & Sanctions: Sometimes, war or political tensions can lead to sanctions or trade embargoes against oil-producing countries. This can remove significant amounts of oil from the international market, leading to supply constraints and higher prices.
- Change in Investor Behavior: War and geopolitical tensions can drive investors to seek ‘safe-haven’ assets. If they view commodities, including oil, as a safe bet compared to other investments, this can drive up demand and prices.
In essence, the primary relationship between war and oil prices revolves around supply and demand dynamics. If war affects either the actual or perceived availability of oil, prices can be expected to rise.