Oil prices rise nearly 3% as Israel-Iran conflict escalates

CALGARY (Reuters) - Oil prices rose nearly 3% on Thursday as the escalation of the week-long air war between Israel and Iran and uncertainty over possible U.S. involvement kept investors on edge.

Brent crude futures rose $2.15, or 2.8%, to $78.85 a barrel, their highest close since Jan. 22.

U.S. West Texas Intermediate crude for July delivery rose $2.06, or 2.7%, to $77.20 by 2:30 p.m. ET.

Trading volumes were thin on Thursday due to a federal holiday in the US.

Israel bombed nuclear targets in Iran on Thursday, and Iran fired missiles and drones at Israel after striking an Israeli hospital overnight.

There was no sign of an exit strategy from either side, with Israeli Prime Minister Benjamin Netanyahu saying Tehran's "tyrants" would pay the "full price" and Iran warning against "third parties" being involved in the attacks.

The White House said Thursday that President Donald Trump will decide whether the United States will get involved in the conflict between Israel and Iran within the next two weeks.

That outlook has sent oil prices higher, said Rory Johnston, an analyst and founder of the Commodity Context newsletter.

“The consensus (in the market) is increasingly forming that we will see US involvement in some form,” Johnston said.

Iran is the third-largest producer among members of the Organization of the Petroleum Exporting Countries, pumping about 3.3 million barrels per day of crude oil.

About 18 million to 21 million bpd of oil and oil products pass through the Strait of Hormuz off Iran's southern coast, and there is widespread concern that the fighting could disrupt trade flows.

The risk of major energy disruptions will increase if Iran feels existentially threatened, and U.S. entry into the conflict could trigger direct attacks on tankers and energy infrastructure, said Helima Croft, an analyst at RBC Capital.

On Thursday, JP Morgan said an extreme scenario, in which the conflict spreads to the wider region and includes the closure of the Strait of Hormuz, could result in oil prices rising to $120 to $130 per barrel.

Even if tensions in the Middle East ease in the coming days, oil prices are unlikely to return to the $60 range they were trading in a month ago, said Phil Flynn, senior analyst at Price Futures Group.

“I think it (the conflict) shakes oil out of its complacency,” Flynn said. “I would say the market is underestimating the geopolitical risk.”

But DBRS Morningstar said in a note on Thursday that it expects any sharp rise in oil prices to be temporary. A higher oil price will exacerbate headwinds for the global economy and oil demand, so as the conflict recedes, the war prize will be depleted and prices will experience a bear cycle, DBRS said.

Russia's top oil official said on Thursday that OPEC+ oil producers should press ahead with plans to increase output, noting that demand will pick up in the summer. Russian Deputy Prime Minister Alexander Novak told an economic forum in St. Petersburg that OPEC+ should carry out its plans calmly and not spook the market with forecasts.