Oil prices jumped 5 per cent after Iran launched strikes against US military bases in Iraq in retaliation for the killing of commander Qassem Soleimani. But by Wednesday afternoon gains in crude had reversed, with prices trading lower than before the Iranian general’s assassination.
Having jumped when markets opened to as high as $71.75 a barrel, crude later dropped to below $66 a barrel, a near 9 per cent peak-to-trough swing in the course of a day.
So why have oil prices failed to rally despite the tensions in the Middle East?
1. The crisis is expected to de-escalate
Oil’s path in the coming days will rest in large part on how the US responds. Many traders are calculating that the US decision not to strike back immediately after Iran’s missile attacks — which did not kill any US or allied forces — was a sign Washington did not want to escalate the situation into a full-blown conflict.
One senior trader at a major commodity house has predicted a period of “relative calm”, with Iranian forces having appeared to have “threaded the needle” by responding forcefully enough to sell a narrative of retaliation domestically for Soleimani’s death without provoking an immediate US military response.
“All that really counts is if an American is openly killed,” the trader added.
Bob McNally, a former adviser to the White House and the head of the Rapidan energy consultancy, agreed that it appeared Iran’s missile strikes had been “deliberately planned to avoid killing US soldiers”. But he warned the attack may not be the end of Iran’s retaliation.
“Tehran frames revenge as the expulsion of the US from the Gulf region and even if it avoids provoking a massive US military attack, the oil market has more risk pricing to do,” Mr McNally said.
Traders cautioned that if the situation did indeed escalate, or if oil supplies were hit, prices could still push well above $70 a barrel.
2. Oil tanker groups are taking a wait-and-see approach
While the Iranian attacks did not target oil infrastructure, the energy market has not escaped unscathed.
Saudi Arabia, the world’s biggest crude exporter and a key US ally, has temporarily suspended shipments through the Strait of Hormuz, the narrow waterway separating the Gulf from Iran where 20 per cent of global oil supplies pass daily.
Saudi Arabia’s state-backed oil tanker group, Bahri, transports crude through the strait, which also is the main route for exports from Iraq, Kuwait, the United Arab Emirates and Iran itself.
Tankers were targeted in the Persian Gulf last year, with Iran suspected of carrying out the attacks in response to the US reimposing sanctions on the country’s oil exports. Tehran has also been blamed by the US for strikes targeting Saudi Arabia’s oil facilities in September, which briefly cut the kingdom’s oil output.
Ship brokers said other tanker operators were also taking precautions, such as only traversing the strait in daylight.
However, Frontline, the world’s largest oil tanker operator, said that while it was “monitoring the situation closely” it had not “suspended trading in the area”.
“I think a lot of people are waiting to see if there are any attacks or direct involvement of tankers,” said Richard Matthews, head of research at Gibson shipbrokers. “Beyond the obvious heightened risk, most people are in wait-and-see mode.”
3. Opec and allies can increase supplies
The oil market’s measured response to the uptick in Middle East tension is in part because any tightness in supplies is, for the moment, largely artificial.
Opec and its allies such as Russia have been trimming production for most of the past three years in an attempt to offset a surge in production from the US shale industry.
If oil prices rose too high, Donald Trump would be expected to pressure allies within the cartel, including Saudi Arabia and the UAE, to boost production to help calm the market. Before the missile attacks on Tuesday the US president said he had discussed oil prices with Khalid bin Salman, Saudi Arabia’s vice-minister of defence.
“[The] Saudis can certainly calm the market by even making statements about a unilateral increase in their supply,” said Iman Nasseri, managing director for the Middle East with energy consultancy FGE. “But that hasty action may not be needed until the military situation between Iran and the US calms down first.”
Mr Trump on Wednesday moved away from a military confrontation with Iran, saying Tehran “appeared to be standing down” after attacking two Iraqi bases hosting US troops in Iraq.
That said, a severe disruption to the Strait of Hormuz could threaten the Gulf state’s ability to get more oil to market, even if the kingdom pumped more.
4. Oil prices are already high
Some traders say the limited price reaction is simply down to oil having already risen strongly in the fourth quarter of last year, with prices gaining about $10 a barrel as concerns over weakening global growth and the US-China trade war receded.
Hedge funds already have sizeable bets on rising crude prices, which have largely been established in the past few months, suggesting there may not be the appetite to keep adding more risk to portfolios without evidence of a genuine supply disruption.
“Not a single drop of oil supply has been lost due to the recent incidents and this is why the oil price has fallen back down again so quickly,” said Bjarne Schieldrop, chief commodities analyst at Norwegian bank SEB.
5. Higher prices = higher supplies
In the back of every oil trader’s mind is this simple calculation, which has arguably become even more germane with the rise of the US shale industry.
While shale’s supercharged growth is projected to slow this year, as companies prioritise generating cash over boosting drilling, stronger oil prices may well bring a swift response from the shale industry to increase output. That is likely to damp enthusiasm among oil traders.
“Oversupply concerns will continue to stalk the energy complex,” said Stephen Brennock at PVM, an oil brokerage.
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Five reasons oil prices failed to soar on US-Iran tensions - Financial Times
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