The current political and economic backdrop gives plenty of ideas to filmmakers. In coming years we shall see movies about events that are currently unfolding in front of our eyes. James Corden will play Boris Johnson in the movie It’s Complicated 2 about the EU-UK divorce. The miraculous escapade of Carlos Ghosn, the former car manufacturing CEO will probably be screened under the title of Adrift in Tokyo or Too Big in Japan. And of course there will be plenty of films about Donald Trump played by Alec Baldwin. Actually the presidency of Mr Trump is likely to be a series with several seasons to be shown. It will be titled GOAT who MAGA. One of these seasons or at least quite a few episodes will be dedicated to his actions towards Iran.
His latest manoeuvre has sent shivers down his foes’ and allies’ spines. The official explanation of the liquidation of the second strongest man of Iran was to prevent imminent attacks on US personnel and interest. It seems a convenient justification at the time of the impeachment of the president and in the run-up to the next election. It is also worthwhile pointing at the ever-growing US independence on foreign oil as another possible reason for the strike. (Note that Venezuelan opposition leader, Juan Guaido was not re-elected as head of Congress over the weekend. The country’s oil production is unlikely to increase in the foreseeable future and the inaction from the US part is also quite telling as the US is now less dependent on Venezuelan oil.)
There is no better way to put it tension in the Middle East has escalated to a level not seen for a long time and the guessing game of the consequences is in full swing. It is interesting to observe that the initial market response to the assassination is very similar to the one last September. We still recall the reaction to the attack on Saudi oil installations. A daily jump of more than $10/bbl after the strike quickly turned into a sell-off as the Kingdom rushed to re-assure the market that the loss of 5.5 mbpd of production will not have a material impact on oil supply. This time around no such assurances have been given. Instead a war has broken out, a war of words, for the time being. This, however, can easily be turned into retaliation, which should have a profound impact on oil supply and market sentiment.
Despite the very clear and present danger of further escalation between the US and Iran/Iraq the market angst significantly subdued yesterday. The early morning rally that took the price of Brent above the $70/bbl quickly turned into long-liquidation. By the settlement prices were well below the day’s highs. It is not entirely clear what caused this weakness and why prices are softening further this morning. Maybe concerns about the rise in geopolitical risk has not eased but the profit-taking was triggered by expectations of a large build in distillate inventories tomorrow. After all, the front-month Heating Oil contract lost 275 points on the day when the two main crude oil futures contracts still posted some gains.
Latest developments did nothing to calm nerves. As said in yesterday’s note Iran would not abide by its commitments of the nuclear agreement. It is not a full withdrawal from the deal nevertheless lifting US sanctions on Iran is now a few steps further away than it was last week. The Iraqi parliament passed a resolution ordering US troops to leave the country. Although it is not a binding one the coalition of foreign forces in Iraq has suspended counter-terrorism activities.
The intriguing and crucial question is whether the recent jump in risk premium will translate into actual supply shortage. When trying to answer this question it helps a great deal to have a look at the map of the Middle East and also look at the enemies and friends of Iran in the region. The first thing that catches the eye is that neighbouring Iraq is aligned with Iran. It is a country with a production of over 4.5 mbpd with international oil companies, including US and UK ones, operating there. With reduced security due to the potential US troop withdrawal these companies might be prone to retaliatory attacks negatively affecting oil output. The geographical proximity of Iran’s foes, Saudi Arabia and the UAE is also relevant. The main Saudi oil hub is on the east coast of the Kingdom and only the Persian Gulf separates these two countries and Iran.
The importance of the two choke points of oil trade, the Strait of Hormuz and the Bab al-Mandab Strait is also evident. The former is located between the UAE and Iran and provides a sea passage to more than 20 mbpd of oil. Exports from Kuwait, Saudi Arabia, Iraq, Iran and the UAE sail through the Strait. On the southwest of the Arab Peninsula is the Bab al-Mandab Strait. There is about 3.5 mbpd of northbound and 2.5 mbpd southbound crude oil and product travelling through this strait. Yemeni Houthis, one of Iran allies, could cause disruption to the oil flow. Further flare up in tensions that affects the operation of either of these strategically important transit routes will have further bullish impact on oil prices. Even without disruptions around these choke points and in actual oil supply the cost of insuring of and providing security to oil cargoes in the region is likely to have gone up after the end of last week making oil purchases from the region potentially more expensive. The consequence one can draw from the latest chapter of the US-Iran relationship is that the geopolitical risk premium is more likely to turn into unplanned supply shortage than disappear. The only questions are when and in what form.