In the hours that followed Iran’s unprecedented drone and missile attack on Israel on Saturday night, City analysts speculated on the potential fallout for oil markets.

The possibility of war across some of the most oil-rich lands in the world raised fears of a renewed cost-of-living crisis, with a former US energy adviser warning of an “escalatory dynamic” in global energy markets.

Nerves are understandable: the pandemic disrupted shipping globally, sending goods prices spiralling, while Russia’s invasion of Ukraine hammered oil and gas supplies, resulting in an energy price shock for much of the world.

But on Monday, the immediate response to the attack was distinctly muted.

Instead of rising further, the price of oil slipped, with a barrel of Brent crude now trading at $89.70 (£71.90), down 2.7pc from Friday’s high of just over $92.

“The actual attack was hardly ‘shock and awe’, it was more like, ‘ready, steady, here they come’,” says John Evans at oil broker PVM.

Max Layton, analyst at Citi, says the immediate reaction in the oil price does not show the whole picture. Instead, he notes the price of a barrel rose from around $85 to just over $90 over the past month – evidence the “attack was already priced” by markets.

“Prices had already rallied notably before the attack occurred (the risk was flagged in advance), and as the calibrated nature of the attack may lead to a pause in direct Israel/Iran confrontation,” he says.

“We believe prolonged tensions through the second quarter of 2024 are now largely priced at $85-90 per barrel.”

Evans agrees: “The salvo of air vehicle attack from Iran into Israel was about as telegraphed a world event that people can remember.

“They might as well have had big disco lights on them and towed banners with ‘come on ladies and gentlemen, please shoot me down’.”

Analysts believe the risk instead lies with any further escalation, particularly ongoing direct conflict between Israel and Iran.

Citi’s Layton says this could lead to oil prices trading up to $100 per barrel or even higher.

He adds; “An example of this could be if Israel moved to directly reduce Iran’s domestic uranium enrichment program.”

It also depends how other oil producers respond.

Goldman Sachs analysis shows that Saudi Arabia and the UAE between them have spare capacity to be able to produce an extra almost 3 million barrels of oil per day should they choose, giving the market a potential cushion.

Iranian production

Iran itself is a significant oil producer. Estimates of its output and capacity vary, but the country has clearly been ramping up production in recent years.

Since the pandemic low of just under 2.6 million barrels a day, the US Department of Energy estimates Iran’s output has risen to more than 4 million per day.

Goldman Sachs by contrast puts current production at a more modest 3.4 million barrels per day.

The country is under US sanctions, which can be powerful in stopping the despotic regime selling to the West.

But other buyers are still available, meaning Iran’s production has an impact on global prices.

Daan Struyven at Goldman Sachs says: “We estimate that Iran crude oil production has risen to around 3.4 million barrels per day (3.3pc of global supply), up about 0.6 million barrels per day over the past two years, with most exports ending up in China.

“If the market were to price a higher probability of reduced Iran supply, then this could contribute to a higher geopolitical risk premium.”

Warren Patterson at ING said cracking down on Iranian exports could leave the world short of oil.

“Iran pumps a little over 3 million barrels per day of crude oil currently and is the fourth largest producer within OPEC,” he says.

“The first risk is that oil sanctions are more strictly enforced against Iran, which could see anywhere between 0.5 million - 1 million barrels per day of oil supply lost. This would ensure that the oil market remains in deficit for the remainder of the year.

“Secondly, there is the risk that Israel’s response includes targeting Iranian energy infrastructure, which would mean the potential for even more significant supply losses.”

Strait of Hormuz

The Iranian regime may not want to cut its own production, but Tehran has a second potential lever over the oil markets: control over the Strait of Hormuz.

This narrow channel between Iran and Oman carries around 15 million barrels of oil a day, making it critical to the global economy. Iran has already seized an Israeli-linked ship in the sea route.

Garbis Iradian, chief economist at the Institute of International Finance, warned in a recent report that “militarising oil by disrupting shipments through the Strait of Hormuz” would hammer global growth.

“About 30pc of global oil consumption passes through this strait, with a large portion of the oil exports from Saudi Arabia, Iraq, Iran, the UAE, Kuwait, and Qatar’s LNG passing through it as well. This makes the strait an important choke point in the global oil and gas market,” he said.

“While it is difficult to predict by how much and for how long energy prices would rise, we assume that oil and natural gas prices surge by 40pc in 2024.”

Petrol and diesel in the UK

When it comes to household living costs in Britain, the most obvious immediate impact will come through petrol prices.

So far this year, oil is up around 16pc, from $77 per barrel to just under $90.

Petrol and diesel are following suit.

The typical price of a litre of petrol has risen by just over 6p to £1.47, according to the Department for Business and Trade.

Diesel has gone up a little faster, with the typical litre now selling for more than £1.56, up from below £1.49 at the start of the year.

Simon Williams at the RAC says the market is sensitive to oil costs: “If the price of oil was to reach $95 a barrel, we could see petrol at the pump go back up to 150p a litre which would be bad news for hard-pressed drivers.”

What happens next?

The future path of oil prices may well depend on the decisions made in Tel Aviv and Tehran in the coming days.

If both sides choose to pause hostilities, the price of crude could ease further. 

Oil may fall to as low as $70 a barrel by the third quarter of this year should Israel and Iran pause their direct conflict, analysts at Citi have said.

But the drone attacks form part of an unsettling backdrop that suggests trade shocks and inflationary pressures are here to stay.

“The unprecedented direct attack by Iran on Israel highlights the increasing challenges to trade security as the West struggles to deal with tensions in Europe (Russia-Ukraine conflict), the Middle East (Houthi rebels disrupting trade via the Suez canal), sub-Saharan Africa and in the future potentially also in Asia (e.g. ongoing China-Taiwan tensions) or possibly South America,” warns economist Christian Schulz at the investment bank.

In other words, even if conflict is avoided between Israel and Iran in the near future, the world is becoming a more unstable place where energy shocks look ever more likely – and may be the least of our worries.