The price of a barrel of Brent could spike from current levels of around $114 to anywhere between $135 and $210 in the unlikely event of a military strike on Iran’s nuclear facilities by the US or Israel. However, this threat is itself a very powerful reason for the West to hold off. Instead, by far the more eminent risk is that near term oil prices will collapse due to an escalation of the financial crisis in the euro-zone.
Oil prices are still some way below the peaks seen during the Arab Spring. (See Chart 1 below) But they have recently been propped up by three factors:
- renewed optimism that the crisis in the euro-zone can be contained;
- reduced fears about the US and Chinese economies, due in part to fresh hopes of monetary easing;
- and persistent speculation that Israel or the US is about to launch a military strike on Iran.
It is hard to quantify the relative importance of these, and other, pressures on the oil price. However, based on the price movements observed after recent news on Iran, worries about a potential conflict with the West are probably already adding between $2 and $5 to the cost of a barrel of crude.
Tensions between Iran and the US, as well as both Israel and Saudi Arabia, are unusually high and have been raised further by the latest International Atomic Energy Agency (IAEA) report on the alleged militarisation of Iran’s nuclear programme and the resulting rebuff by Iran’s envoy to the International Atomic Energy Agency (IAEA) Ali Asghar Soltaniyeh. As a global investment house, geopolitical research – provided by the likes of Stratfor is an essential ingredient of our macro-economic research in a world that is ever more connected.
Nonetheless, any military action against Iran does still appear to be a long way off. The US is struggling to disengage from Iraq and Afghanistan, was reluctant to take the lead in Libya, and has plenty to worry about in Syria and Egypt. Officials have stressed that a strike on Iran’s nuclear facilities, whether by the US or Israel, would have limited benefits but many potential costs, not least the impact on oil prices, and is therefore very much a last resort. Instead, the US is focusing on encouraging other countries to tighten economic sanctions on Iran.
However, as investors regularly ask, it is worth considering what might happen to oil prices if we are wrong. Iran produces approx 3.5m barrels per day (bpd), or 4% of global supply, second only to Saudi Arabia within OPEC. (See Chart 2.) It is unlikely that any military strike would target Iran’s oil facilities, but global sanctions or the withdrawal of supplies by Iran itself could have a similar effect. One useful rule of thumb is that the percentage increase in the oil price required to balance the market following a shock should be roughly five times the percentage reduction in supply. Correspondingly, a temporary halt to Iranian supply might add 20% (4%*5) to the price of Brent, taking it above $135 per barrel.
The impact could be much greater if Iran followed through on past threats to disrupt oil supplies through the Strait of Hormuz, the only waterway available to ship oil from the Persian Gulf. This could reduce global supply by 10-15m bpd, at least temporarily, which might lift the price of Brent to between $180 and $210 per barrel. However, the impact would be offset in part by the release of emergency stocks and there are serious doubts that Iran has the military resources to block the Strait for long.
In all this, though, it important to reiterate that we do not think that a military strike on Iran is imminent. Instead, for the next several years the more likely seismic shock is the break-up of the euro, which could see significant temporary oil price collapsing despite the long term fundamentals and unprecedented demand from the developing world. Some of our energy traders predict a $150 trading range within the next 12 months irrespective of the Iran threat, purely based on demand from the developing world and the fact that the 2008 – 2010 credit crisis virtually evaporated refining and exploration investments in the crucial supply regions. Either way, energy markets will continue to dominate global investment themes for the future.
The Global Fund Exchange Group is an investment management group offering sensible diversified portfolio solutions to institutional investors since 2005. These are often customized to the particular requirements of clients, optimizing returns and controlling risk. Our focus is on the real and evident global macro trends that will shape our planet in future years.
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