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War and Peace - and Oil

2020 has started with a bang. Oil prices have had a turbulent week since the US launched an airstrike in Baghdad, killing Iranian general Qassem Soleimani. With escalating geopolitical tensions between the US and Iran, and factoring in the importance of the Middle East to global oil supply, it’s unsurprising that the price of the commodity jumped to as much as $70 a barrel on Monday 6 January for the first time in 4 months. Investors feared the airstrike that killed Iran’s top military commander might trigger retaliation and disrupt global energy supplies, inciting a crude oil stockpile.

The geopolitical jitters also triggered a surge in the market price of assets perceived as “safe havens” such as gold, the Japanese yen and US, with the market price for gold rose to a near seven-year high of $1,575 an ounce last Monday.

However, despite the initial shock, evidence suggests that oil prices are stabilising. The graph below shows West Texas Intermediate (WTI) crude (a grade of crude oil used as a benchmark in oil pricing) closed at $59.56 a barrel on Thursday, around the same price as where it traded a month ago.

This subdued response to geopolitical tensions in the Middle East may seem surprising considering previous crises which resulted in greater disruptions of the oil market. Take the August 1990 Iraqi invasion of Kuwait for example. It resulted in a surge in the price of oil from $15 a barrel that month to $40 by October ($65.68 adjusted for inflation as of 2019). The lead-up to the U.S. invasion of Iraq in February 2003 led to a spike in prices to nearly $40 a barrel, or around $55 in today’s money.

Why was the response to oil prices so muted compared to previous years? One key reason that geopolitically-driven oil price swings are now more subdued can be attributed to the stabilising effect of US shale oil production on global oil supplies. The US will drive global oil supply growth over the next five years, overtaking Russia and challenging Saudi Arabia as the world’s leading oil producer according to the International Energy Agency’s 2019 oil market forecast. Although the rate of growth in global demand for oil is set to slow as China moves steadily more towards renewable energy sources, the US shale industry will likely boost the nation to the number one supplier position. Its stellar growth in under a decade is partly due to the US shale industry.s ability to quickly respond to price signals by scaling up production, whilst also producing a lighter crude oil which is easier to refine. US oil production grew by 2.2 million barrels a day last year and is set to account for 70% of the total increase in global oil capacity between now and 2024, in what the IEA calls “the second wave of the US shale revolution”.

The impressive growth of shale has pronounced global ramifications, as it has introduced a significant counterweight to the market heavily dominated by Middle Eastern players, and it helps to absorb disruptive events. For example, back in September, when missiles and drones apparently launched from Iran hit oil processing facilities in Saudi Arabia, crude prices surged immediately before falling back, thanks to the slack created in the market by increased supply from the US. Thus far, the oil market’s response to the US killing of Soleimani has been similar, as characterised by a brief spike followed by a return to pre-crisis levels a few days later.

As a result, the United States has become less reliant on imported oil, while members of the OPEC oil cartel, have curbed production. As seen in the chart below, US monthly crude oil exports have exploded since 2012, while imports steadily declined.

But a decreased reliance on foreign oil helps create some room for the US government to act more aggressively in the Middle East than it could in years past. Perhaps rather worryingly, Google Trends saw a spike of people searching “World War 3” just hours after Solemani was shot dead – with the US’s relative oil independence, let’s just hope Trump doesn’t use this as a chance to push a trigger.


Written by Alexandra Butterworth



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