Will the oil price blow up with the Middle East?

Forbes | Michael Lynch: Supposedly a woman approached 19th century German Chancellor Bismarck and confessed she didn’t understand the controversy over Schleswig-Holstein and asked him to explain it, to which he responded, “Madam, only three people have ever understood Schleswig-Holstein.  One is dead, the second has gone mad, and I’m the third and I’ve quite forgot.”  This summarizes how I feel about the current Middle East situation.

The public rhetoric (including tweets) suggests that the U.S. and Russia are both willing to attack each other’s forces, Russia apparently threatening to shoot down U.S. planes and the U.S. planning an attack on Syrian forces that might affect Russian personnel.  This is obviously concerning, and while incidental Russia casualties might not lead to a direct military response, if Russia shot down a U.S. plane (as opposed to an unmanned missile), the U.S. would almost certainly respond.  Given that the Russians know this, they are unlikely to take such a step.

An additional factor is the possibility that Iranian forces in Syria would be hit by any U.S. attack, which might invite retaliation.  Iran is unlikely to be able to attack U.S. forces in the Mediterranean directly, but forces in Iraq and Syria might be subject to ‘asymmetrical warfare,’ i.e., small scale attacks possibly including suicide bombers.  The threat to oil markets come if Iranian actions encourage President Trump to refuse to recertify the Iranian nuclear agreement in mid-May.  While many of Iran’s customers in Asia would not be concerned, there might be some drop in sales from companies fearful of U.S. legal action.  Sanctions on financial transfers would also deter the more conventional customers, but the Iranians should be able to work around that after a brief pause.

Could this also mean an escalation in the conflict between Iran and Saudi Arabia (or more broadly but less accurately, Shia versus Sunni regimes)?  Given that the Saudis have been attacking Iranian-supported Houthis in Yemen without direct response by Iran for some time now, any Saudi actions in Syria seem unlikely to be a provocation that would worsen the situation in the Gulf.

FDR’s comment that ‘we have nothing to fear but fear itself’ seems appropriate for oil traders.  Bombs and missiles flying in the greater Middle East always creates a bullish impetus, even if the oil fields remain distant from the actual violence.  The death of Russian personnel would worsen this, as it implies a greater probability of retaliation and continuation of the conflict which, again, would push up oil prices.  And naturally, should Iranian personnel be affected, there would be very rational concerns that they might respond with some sort of attack that could affect Gulf oil trade.

The worst case scenarios, ongoing U.S.-Russian combat or direct Saudi-Iranian fighting, seem very unlikely to happen.  But as long as the possibility exists, oil prices will remain elevated, with WTI perhaps hitting $70 or higher, and only coming down when it has become clear that the violence is diminishing and will not spread.  Until then, expect a bumpy ride.

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