Escalating tensions between major oil producer Saudi Arabia and Iran sent oil prices sharply higher in the first trading day of 2016 on to the prospect of supply disruption.
Benchmark U.S. WTI (New York Mercantile Exchange: @CL.1)light sweet crude was up 1.9 percent at $37.76 a barrel early afternoon in Asia, after jumping as much as 3.4 percent from the last day of trade in 2015, while Brent (Intercontinental Exchange Europe: @LCO.1)crude was up 2.3 percent at $38.12 a barrel after spiking 2.4 percent over the same period.
The kneejerk reaction came after Saudi Arabia cut ties with Iran, after its embassy in Tehran was attacked by Iranians protesting the Saudis' execution of a prominent Shi'ite cleric.
Heightened tensions between the two OPEC producers troubles investors because most oil Saudi oil production comes from its Eastern Province, which is dominated by Shi'ites, Bernstein's senior oil and gas analyst Neil Beveridge explained.
"This is the area that could potentially suffer if there is an escalation in tensions between Saudi Arabia and Iran," he told CNBC Squawk Box on Monday.
Oil prices were battered last year, sliding over 40 percent on the back of a supply glut.
But despite gains in oil prices on Monday, the risk premium for current Middle Eastern tensions were "incredibly low," said Juerg Kiener, managing director and chief investment officer of Swiss Asia Capital in Singapore,
"I've never seen escalations, geopolitical (tensions) in the Middle East like we see them today and the oil price has hardly moved from the bottom," Kiener told CNBC's Capital Connection.
At around $38 a barrel, oil prices are still at multi-year lows, after OPEC refused to lower its 30-million-barrel-a-day production ceiling at its production meeting in December.
Although there are fears of even heavier output in 2016, with Iran expected to resume exports following the lifting of U.S. sanctions, this risk is a longer-term concern. More current geopolitical concerns and their potential impact on supply are dominating price action, as global spare crude oil capacity is "limited" at two million barrels a day, said Bernstein's Beveridge.
Saudi Arabia produces about 10 million barrels of oil a day, while Iran's output is about three million barrels a day, so any potential supply or shipping disruption would have significant impact on the market, Beveridge added.
Supply interruption in Saudi Arabia and Iran could come at the same time as slowing production at other producers. While the U.S. is exporting crude for the first time in 40 years, production is likely to decline due to a signification reduction in capital expenditure amid the oil price rout, he said.