Oil prices gyrated over the past week, surging higher as war in the Middle East appeared dangerously imminent, but falling back on the seeming de-escalation between Washington and Tehran.
The supply risk is far from over, but the price retreat reflects a world still awash in oil.
As of Wednesday afternoon, crude prices were back to where they were before the assassination of Iranian General Qassem Soleimani, as the world breathed a sigh of relief that war was not in the offing, at least not as of now. The supply risk is far from over, but the price retreat reflects a world still awash in oil.
President Trump gave a speech on Wednesday, saying that “Iran appears to be standing down,” following the Iranian rocket attack on U.S. forces in Iraq on Tuesday. Many analysts interpreted the attack as Tehran seeking retribution for the Soleimani assassination, but Iran also carefully chose targets that would not elicit yet another round of attacks from the United States. The calculation seemed to have successfully threaded a needle – as of Wednesday, it appeared that both governments claimed a victory of sorts, while also seeking on off-ramp from full-blown war.
Oil prices spiked by more than 4 percent late on Tuesday after the Iranian attack, but fell sharply on Wednesday as tensions appeared to be on the wane. “Not a single drop of oil supply has been lost due to the recent incidents and that is why the oil price so quickly has fallen back down again,” said Bjarne Schieldrop, Oslo-based chief commodities analyst at SEB AB.
Geopolitical risk is not over. Saudi Arabia temporarily suspended shipments through the Strait of Hormuz. Trump said he would immediately add new sanctions on Iran, while Iran could use proxy forces to plan further attacks in the region. There is also the small matter of the U.S. military facing expulsion from Iraq in response to the killing of Soleimani at the Baghdad airport. The ill-conceived assassination immediately led to a push from the Iraqi parliament to force U.S. troops out of the country. Trump threatened sanctions on Iraq in response.
Some analysts even speculated that Iran may hold off on a forceful retaliation, keeping an eye on the larger strategic goal of ejecting American troops from Iraq. “What matters is that the presence of America, which is a source of corruption in this region, should come to an end,” Ayatollah Ali Khamenei said on Wednesday.
The larger question for the oil markets is how Iraq figures into the U.S.-Iran conflict.
It’s not clear how this story will play out, but Iraq is a major oil producer at over 4.6 million barrels per day (Mb/d), so the larger question for the oil markets is how Iraq figures into the U.S.-Iran conflict. Iraq had already been beset with protests and instability, with the unrest in Basra late last year of particular concern for the country’s oil sector.
Iraq is OPEC’s second largest producer, and it has tended to overproduce relative to its commitments as part of the OPEC+ deal. More broadly, Iraq has added more than 2 Mb/d in the past decade, one of the world’s largest sources of supply growth (aside from the U.S.), and aims to ratchet that up to 6.5 Mb/d by 2022.
To the extent that the U.S.-Iran conflict moves back into the shadows, it could be Iraqis that pay the price since various attacks will likely take place on Iraqi soil. That also means that Iraq’s oil sector remains at risk. ExxonMobil and Chevron recently evacuated their American staff from the country, even as Iraqi workers keep oil facilities humming along. The pullout could be temporary, but it may have a larger impact if expatriate staff are not able to return.
“The situation in the region remains fragile and the possibility of escalation still cannot be ruled out,” Commerzbank wrote in a note. “In our opinion this justifies a risk premium, so oil prices are likely to remain at an elevated level despite a comfortable supply situation.”
Oil market over-supplied
Oil prices had climbed in the month prior to the Soleimani assassination, driven higher by the thaw in the U.S.-China trade war. But prices also rose because hedge funds and other money managers rushed into bullish bets in the oil futures market. The speculative moves can drive up prices, but they also increase the odds of a snap back in the other direction once sentiment shifts. That shift in sentiment came after Wednesday’s apparent de-escalation. Trader positioning was arguably lopsided to begin with; the calming of tensions on Wednesday likely contributed to a liquidation of bullish bets, dragging down prices.
Nevertheless, the physical market is also well-supplied. U.S. shale continues to grow, although at a much slower pace. Other non-OPEC countries are also adding new supply, such as Norway and Brazil. Moreover, even if there was a supply disruption, OPEC+ keeping around 2 Mb/d of supply off of the market, which can be turned back on virtually overnight. Saudi Arabia has another portion of surplus capacity that it can call on.
Heading into 2020, the IEA estimated that the oil market would still see a supply surplus in the first quarter at around 0.7 Mb/d, which even included the additional OPEC+ cuts agreed to in December. In short, the oil market is not without supply risk, but as long as there is no major disruption, the market could be well-supplied in the early part of this year.