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Oil prices fell more than 5 per cent on Monday after US President Donald Trump paused strikes on Iran, raising hopes that diplomatic efforts could help de-escalate the conflict and eventually restore crude supplies through the Strait of Hormuz.
Brent crude futures fell $5.58, or 5.77 per cent, to $91.20 a barrel by 2204 GMT. US West Texas Intermediate (WTI) crude declined $4.91, or 5.50 per cent, to $84.40 a barrel.
The sharp decline came after oil prices had surged above $100 a barrel amid escalating attacks involving the United States and Iran and concerns over disruption to energy shipments through the Strait of Hormuz.
The waterway is one of the world’s most important oil chokepoints. A significant share of global oil and gas shipments traditionally passes through the strait, making any prolonged disruption a major threat to energy markets, inflation and global economic growth.
Why oil prices are falling
Markets reacted positively to signs that the immediate escalation in the US-Iran conflict could be easing.
US Ambassador to the United Nations Mike Waltz said Trump was “giving the talks some space” before deciding whether to resume strikes. The comments came as mediators continued efforts to facilitate talks between Washington and Tehran.
The possibility of a diplomatic solution has reduced some of the risk premium that had been built into crude prices over the past two weeks.
Oil prices had risen sharply as traders feared that the conflict could further restrict shipping through the Strait of Hormuz. A sustained disruption would have threatened global supplies and pushed energy prices higher.
With the possibility of negotiations now emerging, traders have begun to unwind some of those bets.
However, analysts have warned that the fall in crude prices could prove temporary if the situation on the ground does not improve.
Strait of Hormuz remains key to oil outlook
The biggest uncertainty for the oil market remains the Strait of Hormuz.
Even if active fighting pauses, the return of normal shipping traffic may take time. Tankers and energy companies could remain cautious until there is greater clarity over the security situation.
The situation could become even more complicated if tensions involving Yemen’s Houthis and Saudi Arabia disrupt shipments through other important routes.
This means that even with oil prices falling sharply, markets may continue to carry a substantial geopolitical risk premium.
Relief for consumers and the US economy
A sustained decline in crude prices could offer some relief to consumers, particularly in the United States, where petrol prices have risen sharply since the conflict began.
Average petrol prices in the US have climbed to around $4.11 per gallon, compared with less than $3 before the conflict began, according to motor club AAA.
Higher energy costs have also added to inflationary pressures. US inflation has risen to 4.1 per cent, more than twice the Federal Reserve’s 2 per cent target.
Falling oil prices could therefore help ease pressure on household budgets and reduce the risk of energy-driven inflation.
The decline could also provide some political relief for Trump, whose approval ratings have come under pressure as higher petrol prices and the broader cost-of-living crisis affect American consumers.
The timing is particularly important for the Republican Party, which is seeking to retain control of both chambers of Congress in the upcoming midterm elections.
Will the US Federal Reserve raise interest rates?
The oil-price shock has complicated the outlook for the US Federal Reserve.
Higher energy prices can push up inflation and force central banks to keep interest rates higher for longer. A sustained rise in crude prices could therefore have increased pressure on the Fed to tighten monetary policy.
Markets had been pricing in the possibility of a Federal Open Market Committee rate increase as soon as Wednesday. However, those expectations eased slightly after oil prices fell.
The Fed has kept its benchmark federal funds target in the 3.5-3.75 per cent range since the end of last year.
For now, the direction of oil prices will remain closely linked to developments in the US-Iran conflict.
A durable diplomatic breakthrough could push crude prices lower by removing much of the geopolitical risk premium. But a resumption of attacks or a prolonged disruption to shipping through the Strait of Hormuz could quickly reverse Monday’s decline.
The oil market, therefore, may remain highly volatile, with traders watching diplomatic talks, tanker movements and developments across the region for signs of whether the latest pause marks the beginning of de-escalation or merely a temporary break in the conflict.
With inputs from agencies.
