In contrast to the times when the market was inadequately supplied, the tension in the Persian Gulf region today is not likely to create havoc in the oil market. True, the oil market is and will always remain vulnerable to regional geopolitics, but today when the market is adequately supplied with any number of suppliers, the storyline is different. This is best illustrated by the fact that the oil price today is lower than the time the U.S. came out of the Iranian nuclear deal. As media reports pointed out, “International standard Brent crude closed at $74.16 on May 8, 2018, compared with $70.62 last Friday (May 10). West Texas Intermediate stood at $69.06 last year then, but it ended at $61.66 in the latest session.”
To put the geopolitics of oil in perspective in the era of so-called adequate supply, it will be relevant to look at the global supply-demand equation and the potential and possible magnitude of the tension. Apparently, as reports indicate, both the U.S. and Iran are not inclined to go to war, instead, the U.S.’s stated objective is to take action to change the behaviour of the Iranian regime. Any move to war will have both regional and global ramifications. So it is not surprising, that even regional countries like the UAE, a close ally of Saudi Arabia, has called for a de-escalation of the crisis. The UAE Minister of State for Foreign Affairs Anwar Gargash said in an interview with Emirates News agency that, “it is not in our interest to see an open confrontation.” He added that none of the parties concerned, “have an interest in seeing this current conflict flare up.”
‘‘We have to exercise wisdom, patience and prudence…We will do everything we can to not only avoid war but to de-escalate the current situation,” the minister said.
Thus, oil sentiments have to be seen either in the context of psychological brinkmanship, or some unintended or proxy skirmishes with limited damage. Such moves will lead to an immediate jump in oil prices which will then be moderated by de-escalation moves. This is likely to be the short term scenario.
In appreciating the market dynamics as it unfolds, it will be relevant to factor in issues beyond the region impinging on the market. This will include the economics of the trade war between the U.S. and China and the shrinking demand for oil due to the slowing down of the global market, particularly in Europe. The International Energy Agency (IEA) in its oil market report has revised the demand growth to 1.3 million mb/d from a projected 1.4 mb/d for 2019. This is however still higher when one compares it to 1.2 mb/d in 2018. As the report says, “As we move through Q219, while there is considerable uncertainty on the supply side, it is highly likely that the implied balance will flip into an indicative deficit of about the same size.”
Interestingly, trade wars in the past have had a negative impact on oil prices. As Kathy Lien, financial analyst and Managing Director of FX Strategy for BK Asset Management, observes, “There’s no coincidence that crude prices rebounded 30 percent in a period when U.S.-China trade tensions were easing. This year was off to a good start when the U.S. delayed additional tariffs on China. The S&P 500 hit a record high and oil prices went from $45 a barrel to $65. After Trump issued his latest threat, crude prices tumbled as risk aversion and Chinese growth concerns returned.”
Yet another fallout of the trade war, which could have a bearing on the geopolitics of energy, emanates from the Chinese resumption of oil imports from Iran. During the recent visit of the Iranian foreign minister Mohammed Javad Zarif, reports say that the Chinese oil tanker PACIFIC BRAVO loaded two million barrels of Iranian oil from the Soroosh and Kharg terminals in the Persian Gulf. Clearly, the effect on the oil market is not confined to regional tension alone.
The crucial point is how much global oil demand could mitigate the consequences of a cut in supply. The answer depends on how much quantum of oil supply is going to be cut. Well, zero supply from Iran means that 1.5 mb/d Iranian oil will be not there. This is not a high volume that could not be mobilised when global demand is not soaring and countries like Saudi Arabia are producing below the OPEC quota. It is reported that Saudi Arabia pumped about 9.8 mb/d in March and April though it has an OPEC quota of 10.311 mb/d. Saudi Arabia seems willing to make up for the loss of Iranian oil and it is also reported that some countries are already in touch with it to replace Iranian oil with Saudi supplies.
However, any move to replace Iranian oil by Saudi Arabia will undermine the OPEC collectivity. It will impact upon the OPEC+ solidarity as well. The forthcoming OPEC meeting in June is critical because Iran will oppose any move to increase output and Saudi Arabia will be under pressure from America. In the June meeting, non-OPEC members too will be participating which means Russia will have an equally important role in output. Will Putin listen to his friend Trump and at what price is yet another dimension of oil geopolitics today.
It may be underlined here that a common stake in the oil market has brought Russia and Saudi Arabia closer to the extent that Saudi Arabia, along with the UAE, has tried to push the idea of Russia joining OPEC, a move not appreciated by Iran. This growing proximity between Russia and Saudi Arabia has not been perceived favourably by Iran because it sees this as paving the way for a larger partnership between Russia and Saudi Arabia. The strategic import of this partnership needs to be appreciated in the context of the shifting nuance of American policy towards the region and shared strategic engagement between Iran and Russia on West Asian geopolitics. Iran expects Russia to play an active role in salvaging the nuclear deal. America can still put pressure on Saudi Arabia in particular OPEC, in general, to desist from a production cut in order to hike prices, but unlike in the past Saudi Arabia’s compliance may not come so easily. Already, OPEC has agreed that output can be enhanced if prices move beyond a reasonable number.
Thus, the tension in the oil market is not of its capacity to meet the loss of Iranian oil but is of supply disruption caused by damage to oil installations, pipelines or ports. The drone attack on the Saudi Arabian pipeline or the sabotaging of oil tankers are not the cases of direct confrontation of the kind of blocking of say the Strait of Hormuz would be, but their impact on market sentiment is significant enough to disturb prices. Clearly, as the geopolitics of energy is playing out in its complexity, no prognosis can be made on market behaviour. At best, it remains potentially volatile but paradoxically relatively calm presently.
(The author is a National Fellow at the ICSSR and a former dean at the School of International Studies, JNU. Views are personal.)