Iran leads list of geopolitical risks pushing up oil prices

Iran leads list of geopolitical risks pushing up oil prices
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President Donald TrumpDonald John Trump5 things to know about Boris Johnson Conservatives erupt in outrage against budget deal Trump says Omar will help him win Minnesota MORE’s decision to withdraw the U.S. from the Iran nuclear deal and reinstate all sanctions had been anticipated in energy markets. The price of U.S. crude oil has been volatile in recent days, spiking above $70 per barrel. This will continue to be a dynamic situation geopolitically and economically, and it won’t be a one-day story.

The president’s move will not remove all Iranian crude from world markets — and it may take months before the sanctions against Iranian oil are reinstated — but it will have an impact. It comes at a time when crude oil in storage around the world has been drawn down and markets have been firming.

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Looking out just a couple of years, the fundamentals are even stronger because oil giants’ slashed capital budgets over the last three years will restrain future production growth, especially in higher-cost areas such as deepwater and oil sands.

 

A maxim of investing is that prices move on the anticipation of events but may retreat to former positions when the action actually occurs. This helps explain the tentative stance in general of U.S. producers and investors.

Despite the surge in revenues for oil producers, they have been cautious about hiring more staff and investing outside of hot spots like the Permian Basin in West Texas.

Geopolitical risks in energy are not a new phenomenon. Analysts have been puzzled by the relatively small impact geopolitical events have had on prices until very recently. Consider the risks that have existed during the last couple of years:

  • Saudi Arabia’s quarantine of Qatar and its proxy war with Iran in Yemen;
  • Iranian assertion of power in Iraq;
  • sanctions on Russia;
  • Chinese claims of sovereignty in the South China Sea;
  • multi-country conflict in Syria;
  • continuing chaos in Libya;
  • collapsing production in Venezuela;
  • scandal in Brazil and more. 

Most of the surge in oil prices, until recently, resulted not from those geopolitical factors but from Saudi Arabia’s drive to reach an agreement among OPEC, Russia and others to reduce production. The market has been impressed by the effectiveness of those sustained actions.

The collapse of Venezuelan production and the slowed growth in Brazil also contributed. Pipeline challenges within Canada and between Canada and the U.S. limited growth of oil sands production.

Global markets have been turned upside down in the last five years. U.S. production has doubled despite an apparent effort by OPEC to quash it in 2015 when it maintained production and let prices collapse. This turned into a profound lose-lose action for all producers, and it led to a scramble to maintain markets or find new ones.

Nigerian exports to the U.S. virtually ceased. Saudi Aramco negotiated with Shell to take sole control of the huge Motiva refinery in Port Arthur, Texas. Competition for coveted markets in Asia escalated.

It is often said that the U.S. is the new swing producer, but the reality is that the U.S. will produce all that it can under the constraints of geology, infrastructure and finance.

Only market conditions will rein it in, because hundreds of producers make independent decisions. That means the governments of the world’s major producers have to adjust to prevent another collapse.

The decision on Iran creates some unusual bedfellows. Israel has been vocal in its hostility to the Iran accord. But Trump’s decision today also suits Saudi Arabia, its OPEC allies and Russia.

Falling Iranian exports may take some of the pressure off countries that have reduced production. They will have the best of both worlds — some additional production in an environment of strong prices. 

For now, the only loser in the oil game appears to be Iran. Let’s stay tuned.

Bill Arnold is a professor of energy management at Rice University's Jones Graduate School of Business. He was Royal Dutch Shell's Washington director of international government relations and senior counsel for the Middle East, Latin America and North Africa.