The premium currently built into the crude oil price over tensions between the US and Iran fluctuates according to the daily headlines, but there is an underlying assumption that everything will turn out fine. Global benchmark Brent futures jumped 4.4 per cent on Wednesday to close at $70.35 a barrel, the highest finish since January 30.
The increase was largely driven by news reports that Iran and Russia will conduct navy drills in the Sea of Oman and the northern Indian Ocean on Thursday, just days after Iran's Revolutionary Guards conducted exercises in the Strait of Hormuz.
The military activity was enough to outweigh some positive remarks from Iranian Foreign Minister Abbas Araqchi, who said on Tuesday that the Islamic Republic and the US had reached an understanding on the main "guiding principles" in talks.
In the past 14 trading days Brent has fallen on six occasions and gained on eight, showing it lacks a clear direction and is being driven by the headlines. There is some debate as to the dollar number of the current risk premium, but the consensus range is around $7 to $10 a barrel.
That premium reflects the risk that talks between Washington and Tehran end without a deal and President Donald Trump decides to launch military strikes, with the likelihood that Israel will join in attacking Iran as well.
But the premium is also small enough to reflect that the market believes there won't really be any disruption to crude supplies through the Strait of Hormuz, through which about 20 per cent of global daily volumes transit.
That belief is grounded in past experience, where conflict in the Middle East has rarely led to sustained or major supply interruptions. The logic is that even if you are shooting missiles and bombing each other, it is in everybody's interests that the crude keeps flowing.
The crude market is therefore currently priced for one of two scenarios. The first is that there is a deal between Washington and Tehran that avoids, or at least postpones, military conflict.
This would most likely be a limited deal initially, most likely related to oversight and limiting Iran's nuclear programme in exchange for some sanctions relief. The second is that there is no deal and Trump decides to use the forces currently being built up in the Middle East to attack Iran.
This is more uncertain, as it's far from clear what Trump would actually be hoping to achieve, but the market still takes the view that any military action would leave oil production and infrastructure intact. The scenario the market is not priced for is Iran deciding to go all in, launching attacks on oil infrastructure across the Gulf with the aim of driving prices higher.
This would be predicated on the belief that the one thing Trump will be unable to tolerate is a sustained rise in crude prices, especially heading into what are likely to be tough mid-term elections for his Republican Party.
Iran's leaders could make the calculation that if military action against them is inevitable, it may be better to try to inflict maximum damage on the region's oil production than to accept a limited retaliation campaign and play for time.
While still the least likely outcome of the current tensions, the possibility of a severe escalation and sustained disruptions to crude supply is probably higher than the oil market believes.
(Editing by Sonali Paul)