The escalation of the Gaza crisis will continue to boost the risk premium in benchmark oil prices though well-stocked global inventories and weak demand will cap any move higher.
"We believe this bounce has a little bit more to go but are bearish for the coming few weeks," said Kirk Howell, Partner at Spy Ridge Capital. "While the downside is limited as missiles fly in the Middle East, the over-supply and dropping demand will outweigh the knee-jerk reactions higher over time."
World oil markets are well-supplied despite the loss of nearly 1 million barrels a day of crude from Iran following sanctions by the United States and European Union, the head of the International Energy Agency (IEA) told Reuters on Monday.
U.S. oil demand fell 2.3 percent in October from a year earlier, to 18.4 million barrels a day, the American Petroleum Institute said Friday. Demand was the weakest in October in 17 years, the trade group said, and was up 1.3 percent from September. Demand in the first 10 months of the year was 2.1 percent below the same period in 2011 at 18.562 million barrels a day.
Eleven out of 15 of this week's CNBC survey respondents, or about nearly three-quarters, expect oil prices to climb this week. Justin Harper, Market Strategist at IG Markets said of the firm's clients currently trading oil, 81 per cent hold long positions, or bullish bets.
Four out of the 15, or just over a quarter, forecast a decline. "Despite 'continued' unrest in the Middle East, WTI crude will meander near current levels before moving toward the low $90's," said John Licata, Chief Commodity Strategist of Blue Phoenix, an independent energy and metals research company in New York City. "As of right now, I'm not very optimistic any strength in WTI will hold in early 2013 and I'm currently thinking prices could fall sub $80."
Brent crude - widely perceived as more sensitive to flashpoints in the Middle East - rose $2.75 to settle at $111.70 a barrel on Monday, fueled by supply concerns as violence in the Middle East escalatedand as investors grew more hopeful that a U.S. budget crisis will be averted. Front-month January Brent crude traded as high as $112.20 a barrel during intraday activity, the highest level since Oct. 19.
U.S. December crude rose 2.7 percent on Monday on optimism that legislators will reach a deal to tackle the nation's fiscal crunch, with additional support coming from escalating tensions in the Middle East.
International pressure for a ceasefire in the Gaza Strip puts Egypt's new Islamist president in the spotlight on Tuesday after a sixth day of Palestinian rocket fire and Israeli air strikes that have killed over 100 people.
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Israel's leaders weighed the benefits and risks of
"The confrontation with Hamas is not over yet, it is unclear when it's going to end and we may have to act more extensively and more aggressively," The Jerusalem Post quoted Israel's Defense Minister Ehud Barak as saying on Sunday. Barak said the IDF will not hesitate to start a ground operation in Gaza if it is necessary, but that Israel is also prepared to stop the operation if Hamas stops firing rockets at Southern Israel.
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ANZ analysts said the conflict, according to many observers, is now entering a critical phase. "There are talks of ceasefire in Cairo, but this could take a while to be negotiated," the bank said in a report on Tuesday.
"Deteriorating circumstances in the Middle East mean there is a strong likelihood of higher oil prices this week and over the coming weeks," added Gavin Wendt, Founding Director & Senior Resource Analyst at MineLife Pty Ltd in Sydney. "I think this has every possibility of spiraling out of control."
Though oil markets are moving on speculation that the Gaza conflict may disrupt region oil supplies, the crisis has yet to have any material impact on physical volumes and export flows, and as long as the hostilities remain localized, price gains will be limited, said Johannes Benigni, managing director at JBC Energy.
Furthermore, Saudi Arabia - unlike in 1973 - will not use oil as an economic weapon, said Spy Ridge Capital's Howell. "Now, Saudi Arabia will likely continue to pump as much oil as possible to keep prices stable and further weaken Iran's influence in the region," Howell said. "Unless events drastically worsen, which of course is always possible, oil flow is unlikely to be disrupted. We'd reassess our position if Egypt and Turkey take a more aggressive stance."
The outlook for China's economy, Beijing's structural reform program and a resolution to avoid the fiscal cliff in the U.S. are more pressing drivers for the oil markets, Benigni argued. "China having a new leadership structure may help to get decisions executed and send money to work," he said. "The U.S. has an elected President but I am afraid the lame ducks in Congress will kick the can down the road before they will come to an agreement in Jan."
Oil prices will likely trade sideways in the short term "with more potential on the upside...refining margins are expected to stay relatively weak as refining capacities comes back to work," he added.
Domestic tensions in Jordan meanwhile added to the uncertain political outlook in the Middle East. Hundreds of Jordanians demonstrated on Monday outside the prime minister's offices in protest against fuel price hikes that have met with public outcry over the past week, the AFP reported. Friday also saw unprecedented protests sparked by the fuel issue that included calls for King Abdullah II to go.
"The situation in Jordan piles on the risk premium," said David Kotok, Chairman & Chief Investment Officer at Cumberland Advisors. "Flames of war are spreading in region."
—By CNBC's Sri Jegarajah