Why oil prices haven't skyrocketed on Middle East supply fears — yet

Oil prices have jumped more than $5 a barrel since the start of the week amid intensifying fears that Israel could launch an attack on Iran's energy infrastructure.

The rally, which puts crude futures on track for gains of around 8% week-to-date, has surprised many market observers in that it appears to be somewhat subdued given what's at stake.

Energy analysts have questioned whether oil markets are being too complacent about the risk of a widening conflict in the Middle East, particularly given that the fallout could disrupt oil flows from the key exporting region. Iran, which is a member of OPEC, is a major player in the global oil market. It's estimated that as much as 4% of global supply could be at risk if Israel targets Iran's oil facilities.

Goldman Sachs says a sustained fall in Iranian output could send oil prices up $20 a barrel, while Swedish bank SEB has warned that crude futures could rally to more than $200 a barrel in an extreme scenario.

For some analysts, the reason crude prices have yet to move even higher is because the oil market is short. This refers to a trading strategy in which an investor hopes to profit if the market value of an asset declines.

"There is a very large short position, not only in oil, you [also] see it in equities. In general, the investors don't like this space. Why? They are concerned about a big oil supply glut next year," Jeff Currie, chief strategy officer of energy pathways at Carlyle, told CNBC's "Squawk Box Europe" on Wednesday.

"When we look at the situation today, it is starkly different. Inventories are low, curve is backwardated, demand is middling, it's not great but now you have [China's] stimulus package on top of that, and you still have the OPEC production cuts," Currie said.

"On top of that, we've thrown in potential conflict in the Middle East that could take out some energy facilities, so the near-term outlook is positive, which is why the front of the curve is strong, but it is being weighed down on the back end over the fears of this big oil supply glut," he added.

The market is backwardated, or in backwardation, when the futures price of oil is below the spot price. The opposite structure is known as contango.

Amrita Sen, founder and director of research at Energy Aspects, echoed Currie's view.

"The market is so short. We've never seen these levels of record shorts before," Sen told CNBC's "Squawk Box Europe" on Thursday.

Many oil traders appear to have taken a bearish position on the belief that China's stimulus rally will fail to restore confidence in the world's second-largest economy, Sen said, adding that market participants also tend to expect OPEC and non-OPEC allies to boost oil production later in the year.

"The market has just gotten itself into this fit around bearishness but that's why if it goes, we could be above $80 very quickly," Sen said.

International benchmark Brent crude futures with December expiry traded over 0.2% higher at $77.77 a barrel on Friday, while U.S. West Texas Intermediate futures stood at $73.84, up 0.2% for the session.

Oil's biggest move this week came on Thursday, when prices popped more than 5% following comments from U.S. President Joe Biden over a possible retaliatory move from Israel following Iran's ballistic missile attack earlier in the week.

Asked by reporters whether the U.S. would support an Israeli strike on Iranian oil facilities, Biden said: "We're discussing that. I think that would be a little – anyway." The president added that "there's nothing going to happen today."

CNBC has reached out to the White House for further comment.

Tamas Varga, an analyst at oil broker PVM, told CNBC via email on Thursday that the oil market was pricing in some risk premium given the geopolitical concerns.

"This is why oil is stable-to-higher, equities are weakening, and the dollar is strong. These fears, however, will be greatly alleviated in [the] coming days unless oil supply from the region or traffic through the Strait of Hormuz are materially impacted," he added.

Situated between Iran and Oman, the Strait of Hormuz is a narrow but strategically important waterway that links crude producers in the Middle East with key markets across the world.

"Under this scenario underlying fundamentals will become the driving force again and these fundamentals are anything but encouraging," Varga said.

Israeli Prime Minister Benjamin Netanyahu on Tuesday pledged to respond with force to Iran's ballistic missile attack, insisting Tehran would "pay" for what he described as a "big mistake." His comments came shortly after Iran fired more than 180 ballistic missiles at Israel.

Speaking during a visit to Qatar on Thursday, Iranian President Masoud Pezeshkian said his country was "not in pursuit of war with Israel." He warned, however, of a forceful response from Tehran to any further Israeli actions.

Bjarne Schieldrop, chief commodities analyst at SEB, said that oil prices were surprisingly steady given the high stakes.

"I think it is definitely a little bit about short covering, but [the price rally] is surprisingly weak … given the scenarios that might play out in the Middle East," he told CNBC's "Street Signs Europe" on Thursday.

Schieldrop said Brent crude prices had largely traded between $80 to $85 for around 18 months or so, before dipping below $70 in September. He described the oil contract's recent move higher as "very meager," especially given the "potentially devastating scenarios in the Middle East."

— CNBC's Spencer Kimball contributed to this report.