Geopolitics Is Rearing Its Head Again In Oil

Brent and WTI prices are now at their highest levels in two years. With Brent almost touching US$65/b and WTI within shot of US$60/b, this is cheer for the market, where most participants had resigned themselves to a prolonged period of US$50/b oil. There are several factors propelling this rise. OPEC 's insistence that its supply freeze is working is proving true; despite the rise in American production (and American exports hitting all-time highs), the OPEC deal appears to be slowly clearing out the global glut. And then there has been a re-emergence of something the market hasn't seen in a while – geopolitical risk premium. 

Saudi Arabia's decision to embark on a corruption purge in early November shocked the market. The arrest of some 11 princes – as well as the mysterious killing of a 12th as his helicopter was downed – sparked fears of turmoil was imminent in Saudi Arabia. While much of what goes on (and is going on) in the world's largest crude producer remains a black box. Detractors within the sprawling House of Saud are not unknown, but have previously been dealt with quietly. This very public campaign – which included ‘imprisoning' the ‘corrupt' in the plush Ritz-Carlton – is unusual, and the market worries about what the future could hold. The politics of Saudi Arabia are complicated, and it is unclear where things will end with Crown Prince Salman's current actions. If its future growth from a more diversified economy is all that he wants, things should go on track. If it's just a power grab, things turn out differently.  

What is truly more worrying is the part of an ongoing escalation between Saudi Arabia (and its allies, including the US) against Iran. On the day the purge was announced, Saudi Arabia said it had intercepted a missile fired from Yemen. Then the Prime Minister of Lebanon resigned while in Saudi Arabia, saying he ‘feared for his life'. Bahrain recently blamed a pipeline fire on Iran. This is a slowburn intensification since the Gulf states decided to blockade Qatar.  There must be a lot of politicking going on behind the scenes, but one thing is clear – the Middle East is rapidly positioning themselves into two camps, for Saudi Arabia and for Iran. Threats of war have been declared, and even though it is unlikely right now, the danger is still real. With American diplomacy learning towards the Saudis under Donald Trump with no real peace maker in sight, bold moves could be made and hostilities could break out. Oil prices, naturally, would rise if that happens. But even the notion of it happening is making traders nervous. And keeping prices up. It is a repeat of the situation in 2011-2013, when the Arab Spring sent prices soaring. 

Based on basic supply/demand fundamentals, the level of crude prices right now should probably be with the range of US$50-55/b. The market has been adding on a risk premium to prices due to the current Middle East tensions. This could rise if Iran-Saudi Arabia relations continue to sour or unless it also derails the planned extension of OPEC production cuts in March 2018! Rising American production is also not pacifying the market, after five weeks of declines, American rig owners added nine new rigs last week, tempted by rising prices. It is likely oil price stay within US$60/level through the end of the year. Some traders are betting it will go further. A flurry of trades last week betted on Brent to hit US$80/b by Christmas. There might be smiles if that happens, but for that to occur there will have to be some serious supply disruptions in the Middle East.

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WTIOPECBrentGeopoliticsMiddle EastSaudi ArabiaIranUSA

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