Investing.com– Oil prices retreated Monday, as the limited damage done by the Iranian strike against Israel over the weekend prompted the market to downplay the risk of a broader regional conflict 

At 08:40 ET (12:40 GMT), fell 0.7% to $85.04 a barrel, while dropped 0.8% to $89.75 a barrel. 

Crude prices had surged to a five-month high earlier in April as markets feared any potential disruptions in Middle East production given the uncertainty in the region.

While oil prices remained in sight of recent highs on Monday, they showed a somewhat muted reaction to the Iranian strikes – indicating that fears of worsening geopolitical tensions may already be priced into oil prices.

Iran attacks Israel, retaliation in focus 

Iran launched a wave of missile and drone strikes against Israel over the weekend, retaliating for an alleged attack on an embassy in Syria.

But analysts said that the attack presented limited upside for oil prices, given that it was largely telegraphed and caused little serious damage. 

Tehran also signaled that it did not plan to carry out any further attacks.

Israel’s response to the attack is now expected to determine just how the conflict will play out, and whether it could spill over into the broader Middle East region. 

“The conflict could still be contained to Israel, Iran and its proxies, with possible involvement of the U.S. Only in an extreme case do we see it realistically impacting oil markets,” ANZ analysts wrote in a note. 

That said, Goldman Sachs noted that the geopolitical situation and the potential Israeli response remain highly uncertain.

“While we estimate that oil prices already reflect a $5-10/bbl risk premium from downside risks to supply, we continue to see significant portfolio hedging benefits from investing in oil against negative geopolitical shocks,” Goldman analysts said, in a note dated April 14.

The risk of a direct conflict escalation adds $5-$10 a barrel to Wells Fargo’s price forecasts, the bank said in a note.

“If the current Middle East conflict expands and/or intensifies and physical volumes are curtailed, then we expect a much higher oil price would result. At a minimum, we believe a physically disrupted market could
retest nominal oil price peaks around $140/bbl,” the U.S. bank added. 

Middle East disruptions offset by spare capacity 

ANZ analysts tend to disagree, stating that the actual impact of Middle East disruptions on global oil markets would be limited, given that major producers still had ample spare capacity to push up output. 

“OPEC recently reiterated its supply policy, with recent production cuts extended until the end of June. However, that leaves it with approximately 6.5mb/d of spare capacity. Most of this could be quickly brought online should disruptions emerge,” ANZ analysts said. 

Still, with lower OPEC production in the coming months, and with the Russia-Ukraine conflict also disrupting some oil production for Moscow, global oil markets are likely to remain tight in the near-term. 

On the other hand, fears of softer demand are also expected to remain in play, especially after dismal economic data from top importer China. China is set to release its first-quarter figures on Tuesday. 

(Ambar Warrick contributed to this article.)