It’s summer. It’s hot. We all want to go on vacation. But for those of us who watch the oil market, there’s a nagging feeling that we won’t get to read that trashy novel on the beach, because oil prices are ready to explode.
Who’s to blame?
Top of the list is Iranian President Hassan Rouhani who, on Sunday, warned the United States that conflict with the Islamic Republic would be “the mother of all wars.” Additionally, Rouhani’s comment that “We have always guaranteed the security” of the Strait of Hormuz — the comparatively narrow waterway from the Persian Gulf into the Indian Ocean, through which 40 percent of the world’s oil exports pass — was regarded as endorsing, rather than contradicting, Iranian threats to actually close the strait.
Rouhani’s words prompted President Trump to tweet his own warning, in capital letters.
Unsurprisingly, oil prices initially were up Monday but, at the time of this writing, had fallen below last Friday's close. West Texas Intermediate, the significant market indicator, remained below $70 per barrel.
Still, a new analysis has aroused other concerns. Veteran oil market-watcher Philip K. Verleger released a report from his firm, PKVerleger LLC, anticipating oil prices at $200, with the possibility of a surge to $400 per barrel, in the next 12 to 18 months.
Verleger’s focus was on an esoteric lack of diesel fuel, rather than geopolitical threats exchanged between Rouhani and Trump. But his analysis cannot be dismissed lightly. Refineries across the world are having to recalibrate to produce low-sulphur diesel to meet new environmental regulations, prompting shortages that can push prices up.
For those perplexed by the functioning of oil markets, here are a few guidelines to work out what is important:
Geopolitics: This is the fancy term for wars and crises. If the war is in the Middle East, this can be bad for oil markets, although the carnage of recent years in Syria and Yemen has been, in market terms, just background noise. The market can probably cope with reduced or even zero Iranian oil exports — but if Saudi exports were cut back, the impact would be bad.
All the talk about the Strait of Hormuz is, to my mind, a distraction: The inbound and outbound shipping lanes actually lie in Omani territorial waters; if Iran threatened tankers militarily (floating mines or fast boats are the obvious options), the U.S. Fifth Fleet, with the support of U.S. allies, would respond promptly and forcefully. I suspect Iran would prefer tactics where its fingerprints are less obvious — such as sabotaging Saudi or Bahraini oil installations, or encouraging insurrection by Shia Muslim communities in these countries.
OPEC and OPEC-Plus: Oil-exporting countries like high prices, which give them more money to spend at home (or in the south of France and similar places). A couple of years ago we may have thought that we had said goodbye to the Saudi-led cartel, but Riyadh teamed up with Moscow (hence “OPEC-Plus”) to restrain production, and especially to run down large stockpiles. The result is the current pricing. So far, recent talk of increasing production so that prices don’t go too high has been just talk.
Economics: Growth is good overall but it also increases demand for energy, thereby prompting price increases. Currently, the world economy is growing nicely; hence, the oil price increases of recent months. The growing prospect of a tariff war between the United States and China introduces a major uncertainty, which is bad for economic growth.
Technical factors: This is geek-speak for refinery and pipeline constraints. A barrel of crude oil is unusable as such; it needs to be subjected to “fractional distillation” in a refinery, producing diesel, gasoline, heavy fuel oil and a range of non-transport products, some even used in pharmaceuticals. The demand for each product is different and the various fractions cannot be adjusted significantly. A particular U.S. concern is pipeline availability; some of the new shale oil cannot be sent to refineries because there are not enough pipelines. And no one apparently wants a new pipeline route to go anywhere near their backyard.
So, plenty of possible threats exist to any practical calm in the oil markets — which, additionally, are worldwide, rather than regional. (Minor price differences between the United States, Europe and Asia reflect varying qualities of crude oil and distances from principal markets.)
The markets are sophisticated enough to absorb small amounts of bad news and presidential tweets but, like most us, don’t like uncertainty. Current political rhetoric is not helpful. It’s almost as if the story line from the trashy novel we wanted to read has become real life.
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