As Middle East tensions boil over, why isn't oil surging back to $100 a barrel?


June 26, 2019 08:13:49

They don’t make oil crises like they used to.

Key points:

  • So far the oil market’s reaction to rising tensions between the US and Iran has been muted
  • Increased US oil exports are plugging the shortfall caused by trade sanctions against Iran
  • Threats of a global economic slowdown are dragging the oil price down, but that may change if US/Iran hostilities mount

In the past week or so, the world’s tightest and most tenuous chokepoint for the oil trade, the Strait of Hormuz, has seen a flurry of activity — and none of it good.

Tankers have been attacked, left ablaze and abandoned nearby in the Gulf of Oman.

A US military drone has been shot out of the sky, US retaliation was narrowly avoided and the rhetoric between the perennially hostile US and Iran has become even more bellicose.

All that has seen the price of oil rise by less than 10 per cent to the not particularly historically challenging level around $US65 a barrel.

Despite the relatively muted global response, it has seen some outsized moves in prices for Australian motorists.

Sydney, Brisbane and Adelaide’s unleaded petrol jumped by between 15 and 24 cents a litre, while prices fell in Melbourne, Perth and the bush. Go figure.

However, compared to some of the great oil contretemps of history it is hardly visible as a blip.

Back in 1973, an Arab embargo on oil exports to nations supporting Israel during the Yom Kippur War saw oil prices rise around 400 per cent.

Six years later prices doubled during the Iranian revolution.

There was another 100 per cent bounce in 1990 as Iraqi tanks rolled into Kuwait.

The oil crisis in the 2000s was a much slower-moving event with prices grinding up from below $US30 a barrel at the turn of the millennium to $US140 by 2008.

The GFC punctured that.

Since then it has bounced around as markets’ bulls and bears have wrestled to make sense of the often massive swings in projected supply and demand.

US oil production surges

So why hasn’t the latest Middle East sabre-rattling caused greater alarm?

The principal reason is global oil traders are more worried about the slowing global economy, which on their modelling translates to falling demand and prices.

The other big difference from earlier shocks is the rapid shift of the US from energy importer to exporter.

By late last year, the US powered past both Russia and Saudi Arabia to be largest oil producer on the planet.

The US shale producers have proved themselves to be nimble at either ramping up or down production, responding quickly to price changes in the global market.

Iran sanctions

With the Trump administration last month ending the exemptions granted to eight big oil importers — including India, China, Japan, South Korea and Taiwan — to source oil from Iran, it’s little surprise US producers are the big winners.

India, the world’s third-largest oil importer and Iran’s second-largest customer behind China, has dramatically changed its purchases since the US imposed sanctions on Tehran in November.

Indian imports from the US have averaged more than 180,000 barrels a day over the past six months, a 350 per cent increase on the 40,000 barrels in the same period a year earlier, according to data compiled by Reuters.

India’s imports from Iran halved over the same period, and with the sanctions re-imposed it will soon be in round figures, around zero.

In other words, US producers have become quasi shock-absorbers filling up any sudden loss of supply such as that hitting Iran.

A softer US dollar has helped its cause in recent weeks.

RBC analyst Michael Tran argues the weaker greenback has “become favourable to the point where the US is aggressively pricing to rid itself of barrels”.

“Given recent activity in the US Gulf, we would be surprised if exports did not retest the all-time highs of 3.6 million barrels a day in the coming weeks, if not higher,” Mr Tran said.

Higher volumes, earning higher export prices; it’s a sweet-spot for the US and helps to narrow President Donald Trump’s detested trade deficit.

Global economic worries

That has meant geopolitical risks are not felt as acutely as before, except perhaps in the case where the global economy keels over.

“With global economic growth expected to be in its last leg of the expansionary cycle and risks to growth much higher, especially from geopolitical risks emanating from US-China trade war, nobody wants to be caught wrong-footed at this stage, especially after a lot of the investors were burnt in the year end sell-off,” JP Morgan commodities strategist Abhishek Deshpande wrote in a research note last month.

“Despite the recent increase in oil prices, its sustainability has been questioned.

“As risks to the global economy are likely to impact near-term demand for oil products, there are also growing concerns over long-term demand.”

Mr Deshpande noted the impact of geopolitics on oil seems to be subdued despite much higher risks and supply disruptions in the past few years compared to earlier in the decade.

“In fact even in high risk to supply scenarios such as oil-based sanctions on Venezuela, market participants have frequently focused on ‘how quickly would Venezuela’s production come online post-regime change’, instead of asking ‘for how long and by how much is the supply disruption going to tighten global oil markets’.”

Market on a knife’s edge

It should also be noted that Iran’s ability to export has not entirely dried up, bit it has become far murkier.

It has still managed to ship out 300,000 barrels a day in June, well down from its around 2.5 million barrels a year ago, but still 300,000 more than the US wants.

The Iranian oil has found its way to United Arab Emirates, Turkey, Singapore and Syria, although as Refinitiv points out, “these may not be the final destinations”.

That is unlikely to please the US and may lead to tensions in the region ratcheting up a notch or two.

At the moment, the oil market is delicately poised.

“On the bullish side, an increased probability of a trade truce and/or weaker dollar could possibly provide the much talked about thrust under oil prices,” Mr Deshpande said.

“However, on the bearish side, continued weak macro dynamics and lingering concerns around US-China trade talks could be sufficient to put a cap on oil prices despite the risks mentioned above, especially if OPEC members (and allies like Russia) start to quietly increase supply as observed last year.”

Of course, if the war of words straddling the Strait of Hormuz escalates into outright military hostility, and 30 per cent of the world’s seaborne oil becomes stranded, the market’s calculations would be far less binary.

Prices would shoot up, probably to $US100 a barrel and beyond, and oil would regain its ability to shock the world.

And there wouldn’t be any need to theorise about a possible global economic slowdown — it would become an entrenched fact.






First posted

June 26, 2019 05:03:18

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