In the past year, we have seen many disturbances in the Middle East involving the U.S., Iran, and Iraq as well as Saudi Arabia. The recent killing of Qassem Soleimani – commander of the Iranian elite Quds brigade – and the Iranian response, has brought the region to the edge of new military conflict. 

Have oil prices become resilient to geopolitical tensions, at least when it comes to the Middle East?

Despite high tensions, oil prices have remained relatively stable (until the current outbreak of coronavirus). Prices experienced a brief jump from $66 per barrel on January 1 to nearly $70 and then quickly backed down to $65. So, have oil prices become resilient to geopolitical tensions, at least when it comes to the Middle East?

According to Muhammad Sahimi, an expert on oil and Iranian nuclear and political development and professor at the University of Southern California, the reason that the price did not go much higher and did not stay high is that the recent assassination of General Soleimani did not escalate into a wider war. Neither side wanted war, and both decided to de-escalate. Otherwise, the oil price would have spiked much higher.

Dr. Gal Luft, co-director of the Institute for the Analysis of Global Security (IAGS), a Washington-based think-tank explains that the price of oil is only partially impacted by geopolitical events, and that the market has proven itself to be quite resilient in the face of the instability in the Persian Gulf and the September attack on Abqaiq—the Saudi Aramco oil-processing facility. Greater influence can be attributed to economic conditions related to trade wars, declining global growth, and currency factors. The persistent low-interest environment also contributes to the flow of capital from commodities into equities and other speculative assets. 

“We are living at a time in which the fundamentals are secondary.”

“In short, we are living at a time in which the fundamentals are secondary,” Luft told Inside Arabia, adding that one could not ignore the oil gushing out of North America which has more than offset the drop in supply from Iran, Venezuela, and Libya, contributing to a low price environment.

However, there are some other variables, that should be taken into account. With a pandemic of coronavirus, there could be a significant drop in oil prices, which would impact the movement of people and goods worldwide, according to Luft.

Apart from this unexpected health concern, there are other worrisome issues that put the focus back on the Middle East. Dr. Cyril Widdershoven, a veteran global energy market expert and founder of Dutch consultancy Verocy, explained that mainstream market analyses promote the thesis of ample supply in the market, which when combined with a still relatively high oil and petroleum storage volume, counters possible supply risks. 

This premise has been supported by the quick response of Aramco after the attack on Abqaiq and reports supported by the U.S. Energy Information Administration and International Energy Agency about shale oil growth in 2020, which would bring additional capacity to the market. What many analysts are getting wrong, according to Widdershoven, is that they combine supplies of all available crude qualities, including light shale oils, in one general number. 

“Data on U.S. shale oil exports are not based on a very high growth but on the lack of interest or capability to use shale oil in refineries and even [though the] U.S. is exporting, they are increasingly needing additional foreign volumes (mid and heavy crudes) to keep their refineries running,” Widdershoven told Inside Arabia.

In this context, any disturbances of Middle Eastern supply would have serious consequences for oil prices, especially if countries are ignoring the geopolitical and supply risks, and in the event  the total spare capacity available is low—particularly if Iraq or Libya implode further. 

This scenario is quite possible. 

As the spare capacity of OPEC is by and large only assured by two states, Saudi Arabia and UAE—as other members are barely reaching their own set targets—it is not surprising that both countries have been very cautious toward Iran, ever since the September attacks on Abqaiq. Physical removal of their spare capacities would drastically change the current equation.

While Luft has doubts about any spectacular Iran response, others suggest that Tehran has not really begun executing its revenge for the killing of Soleimani. Iran, after all, has all the motivation to do so. 

“Tehran cannot be showing fear to act, while it needs to find a new enemy very soon outside of Iran to bring some stability in the country.”

Widdershoven is convinced that Iranians will surely retaliate in the next few months. “Tehran cannot be showing fear to act, while it needs to find a new enemy very soon outside of Iran to bring some stability in the country,” he noted. 

Iran’s approach is to wait until the end of Trump’s presidency while hoping to negotiate with a less hostile U.S. administration. Since many observers believe that the fall of Iran’s economy is happening faster than expected, Iran would be very tempted to “help” Trump pack his bags and leave the White House. 

Arguably, higher oil prices lasting for some time, as a consequence of new turmoil in the Middle East, would hurt Trump’s chances of a second term, especially if higher oil prices push the cost of gasoline in the U.S. well above $3 per gallon. 

Simon Watkins, a financial journalist, writes that “every US$10 per barrel change in the price of crude oil results in a 25-cent change in the price of a gallon of gasoline” and “$90-95 per barrel of Brent oil price equates to around $3 per gallon of gasoline.” 

Watkins also cites the findings of the American Automobile Association claiming that “for every cent that the national average price of gasoline rises, more than one billion dollars per year in discretionary additional consumer spending is estimated to be lost”—very bad news for the Trump administration in an election year. 

Retaliation would not be similar to Iran’s attack on the Iraqi base in which U.S. forces were housed, instead they would be executed through Iran’s proxies and allies.

In Sahimi’s opinion, retaliation would not be similar to Iran’s attack on the Iraqi base in which U.S. forces were housed, instead they would be executed through Iran’s proxies and allies. 

While it is not likely that Iran would block the Strait of Hormuz – the world’s largest oil choke-point — Widdershoven posits that in the case of new retaliation, Iran will likely open a second or even third front in Iraq, Syria, Lebanon or Yemen, while “attacking oil-gas and energy /water infrastructure in the Arab world with cyber-attacks.” Iran is more than capable of carrying this, without being directly involved. 

The possibility of bringing down Saudi Aramco would hit the market with a major bang. No other producers are able to supply the market to its capacity, while the costs of restoring production could take months. Any of the above scenario would send oil prices sky-high for a long time and $90-100 per barrel marks would easily be hit. 

Widdershoven observes that markets do not understand the surgical nature of Abqaiq attacks, which did not damage the critical parts of the oil complex, yet new attacks can take out the plant for a much longer period of time.

When the financial markets become aware of the real crisis at hand, realizing that OPEC storage volumes are not sufficient (in the event that production plants are out) and that this cannot simply be countered by supplying the market from Aramco oil storage, all hell will break loose, according to Widdershoven. 

Iranian revenge would seem to be a dish best served cold, and the Trump Administration better be ready for it.