As Conflict Escalates, Oil Markets Fear the Worst - TheStreet

History is a tough habit to break.

With Israeli and Palestinian tensions escalating, oil prices are soaring. The

New York Mercantile Exchange Index

November contract for light sweet crude traded as high as $37 Thursday morning and is currently trading well above $35. And while a little more than a year ago, oil prices neared the single digits, history has a way of reminding skeptics what a powerful grip, deep-rooted in cultural differences, it can have on the world economy.

While Israel poses little threat to the oil supply, the possibility of deeper Arab involvement poses an ominous risk to the supply of oil to the U.S. "It all boils down to supply and demand," says Dan Pickering, director of research at

Simmons & Co.

, a Houston energy-research firm. "Tensions in the Middle East create a supply issue -- the Arabs using oil as a political weapon and reducing supply."

While there is no indication that the Israeli-Palestinian conflict is spreading beyond contested territories in the West Bank and Gaza, rhetoric and symbolism have spooked the oil markets. For the first time since 1996, the Arab League has scheduled a formal meeting, signaling that the issues have grown in scope. "The issue has clearly moved beyond an Israeli/Palestinian issue," Pickering says. "Middle East issues are again becoming intertwined. This now involves Syria, Saudi Arabia, Kuwait and others, at least from a rhetorical perspective."

And the oil markets fear the worst: That rhetoric could escalate into more destructive behavior. "If it moves from talking about it to acting on it, one of the arrows in the quiver is oil -- another is diplomacy, another is military action," Pickering said.

If tensions grow, it is likely American support for Israel will grow with it. And that could lead to oil-based retribution from Arab nations. "You could be back to the 1973 scenario when the U.S. supported Israel in an arms issue, and the Arabs said, 'No more oil,'" Pickering says. "That is what led to the embargo."

As missiles fly around the West Bank, oil prices will creep higher. The fact that the U.S. is entering winter, when demand for crude and crude-related products escalates, makes the problem more critical. "The timing couldn't be worse," says Pickering. "Supply is already very tight, and upsetting

those Arab nations with excess capacity is not a good thing."

Oil futures are clearly reacting to the risk of the worst-case scenario. "The crude market is saying to assume the worst," Pickering opines. "If the worst happens, the shorts

in the oil market get killed."

History appears to be showing its face again.

How will events play out in the financial markets? Discuss it on our Middle East board.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to

Chris Edmonds.