Welcome to The Geopolitical Energy and Risk Monitoring Report by Dan Graeber, a commentary on the intersection between geopolitical events and the price of oil. Our indicator is based on the expected price volatility by the end of the current trading week.
Risk level: Orange
RED: Severe (+/- 4%) ORANGE: High (+/- 3%) YELLOW: Elevated (+/- 2%) BLUE: Guarded (+/- 1%)
THE BOOSTER SHOT
- Risk is back in spades.
- Threat of war in the Middle East spares oil so far.
- Physical market concerns are on the consumer side.
The US military on orders from the president took out the leader of the elite Quds force last week in a targeted strike on Baghdad International Airport. The strike created geopolitical shockwaves and triggered calls for restraint, but the market so far has suffered only a psychological blow. During the weekend, however, President Trump took to Twitter to warn Iran that more attacks may be coming. But the epicenter of geopolitical risk in Iraq is in Baghdad, far from the southern port of Basra that exports over 3 million barrels of oil per day to the global market. With a revered figure out of the picture, however, Iran and its proxies may favor a shadowy approach to conflict that renders physical market issues moot.
Crude oil prices on Friday spiked as much as 4 percent on the back of the geopolitical risk premium supported by the death of Qasem Soleimani, the Iranian military commander. Markets were otherwise influenced by signs of a slowdown in US shale output in 2020 and concerns about the impact of the International Maritime Organization’s sulfur cap on marine fuels. There will be a continued risk premium moving forward, though Brent managed only a 0.65% gain last week.
A “maximum pressure” campaign from Washington designed to persuade Iran to return to the negotiating table has backfired. Instead of forcing Iran’s diplomatic hands through sanctions, sudden military pressure has only emboldened resistance from Iran. Sanctions have already taken a toll, with the International Monetary Fund expecting a 9.5% contraction in real GDP for Iran this year. Sanctions, however, have not curbed the Iranian activity that Washington says is detrimental to regional national security. And with a weekend tweet from Trump threatening Iranian cultural sites on Iranian soil, the gloves are off.
Iran has shown its ability to disrupt maritime traffic in the Persian Gulf and unsettle oil markets with attacks on Saudi Aramco facilities in September. Up until now, few of the Iranian actions were met by any sort of real military response. But by late December, the US administration had enough. US military forces targeted a militia in Iraq, Kata’ib Hezbollah, claiming it was responsible for the death of an American contractor earlier in the month. Finally declaring there was indeed a threat to US security interests, the US acted with force. The consequences were telling of the turning tide in the Middle East.
“The US Forces relied on their own conclusions and political priorities, not the priorities as assessed by the government and people of Iraq,” a statement from Iraq’s National Security Council read days before Soleimani was killed.
There is a growing risk premium supporting the price of oil, but if last year told us anything it is that the market is becoming somewhat risk averse. Days after Saudi Aramco facilities were struck in September, crude oil prices jumped some 14% to push Brent to $69.02 per barrel. Brent finished September, however, at $60.71/bbl. Brent futures spiked to $69.16/bbl in intraday trading last Monday, the highest since the September attacks on Aramco, but settled to $68.60/bbl by the end of the day on Friday. There is no real risk as of yet to oil in the Middle East. On Friday, our showed three VLCCs loaded some 5.6 million barrels of oil from the port of Basrah. In terms of oil, nothing physical has changed.
The real risk is a strategic one. US military action in Iraq has frustrated not just Iraqi political figures, but the general public as well. In December, the Shiite south of Iraq was unsettled by protests that featured slogans against the Islamic republic. After US airstrikes on Kata’ib Hezbollah, those slogans turned anti-American. US Secretary of State Mike Pompeo spent the last few days working to assure regional allies that cooler heads should prevail, yet the Defense Department followed with commitments to thousands of more American troops to the region. But in Iraq, lawmakers opted to tell those forces not to bother and go home. What fills the vacuum in the Middle East will have profound implications for generations to come.
Crude oil prices are rallying Monday on the back of a geopolitical risk premium and will likely ride that wave for the foreseeable future. Members of the US Congress and British Parliament returned to work on Monday, so expect markets to move on some of the rhetoric from returning lawmakers. In the markets, watch for readings of consumer prices in major economies. We get a reading for December from the Europeans on Tuesday. Wednesday brings the usual EIA fare and another likely draw to US inventories. With China already flooding its economy with cash, pay attention to what Beijing reports with loans and financing on Thursday. The week ends on a quiet note, though Mexican PMI readings and speeches from US Fed officials may warrant attention. With war clouds looming on the first full trading week of the new year, an Orange alert is in place, with Brent expected to move by at least 3 percent on the week.