• Oil prices dropped by over $3 a barrel following Israel's retaliatory strike on Iran, which did not disrupt energy supplies.
• The limited nature of the strikes has raised hopes for a de-escalatory pathway, reducing the geopolitical risk premium in oil prices.
• The market is now watching for Iran's potential counterattack, which could influence future oil prices.
• The recent strikes and their impact on oil prices highlight the relationship between geopolitical events and global energy markets, reminding us of the volatility of the oil market.

The global oil market experienced a significant jolt as oil prices plummeted by more than $3 a barrel on Monday. This unexpected drop was triggered by Israel's retaliatory strike on Iran over the weekend. The strike, which strategically bypassed Tehran's oil and nuclear facilities, did not disrupt energy supplies, thereby easing geopolitical tensions in the Middle East.

The Israeli retaliation was a response to an Iranian missile attack on October 1. This attack had led to a surge in oil prices as markets priced in uncertainty around Israel's potential response and the upcoming U.S. election.

The Israeli retaliation involved three waves of strikes against missile factories and other sites near Tehran and in western Iran, marking the latest escalation in the ongoing conflict between the two Middle Eastern rivals.

The Impact of Limited Strikes on Oil Prices

However, the limited nature of the strikes, which notably avoided oil infrastructure, has raised hopes for a de-escalatory pathway. This has resulted in the geopolitical risk premium that had built up in oil prices in anticipation of Israel's retaliatory attack coming off, according to analysts.

Saul Kavonic, a Sydney-based energy analyst at MST Marquee, noted that the more limited nature of the strikes has raised hopes for a de-escalatory pathway, which has seen the risk premium come off a few dollars a barrel.

The market is now closely watching for confirmation that Iran won't counterattack in the coming weeks. If Iran maintains restraint, it might temporarily depress the risk premium, but any sign of escalation could lead to a price increase.

Commonwealth Bank of Australia analyst Vivek Dhar expects market attention to turn to ceasefire talks between Israel and Iran-backed militant group Hamas that resumed over the weekend. Despite Israel's choice of a low aggression response to Iran, Dhar expressed doubts that Israel and Iran's proxies -- Hamas and Hezbollah, are on track for an enduring ceasefire.

OPEC+ Response and Historical Precedents

In response to these developments, Citi lowered its Brent price target in the next three months to $70 a barrel from $74, factoring in a lower risk premium in the near term. Analyst Tim Evans at U.S.-based Evans Energy suggested that the market might be somewhat undervalued, with some risk that OPEC+ producers may push back the planned increase in output targets beyond December.

In October, the Organization of the Petroleum Exporting Countries and their allies, a group known as OPEC+, kept their oil output policy unchanged, including a plan to start raising output from December. The group will meet on December 1 ahead of a full meeting of OPEC+. The group's decision will be closely watched, given the market's response to the reduced geopolitical risk and the potential for Iran's reaction.

Historically, geopolitical tensions in the Middle East have often led to fluctuations in oil prices. For instance, during the 1973 Arab-Israeli War, Arab members of OPEC imposed an oil embargo against the United States, causing a severe spike in oil prices. Similarly, the 1990-1991 Gulf War led to a sharp increase in oil prices due to fears of a supply disruption.

However, the current situation differs in that the Israeli strikes did not target Iran's oil infrastructure, thereby not disrupting energy supplies.