Oil bulls have long scratched their heads about stubbornly low oil prices, despite a multitude of ever more threatening geopolitical hotspots. In a recent opinion piece,
I have argued that the root cause was perhaps not so much the lamented Chinese demand deficit. Prices might be artificially low because restrictive monetary policies by central banks have rendered forward arbitrage trading unprofitable and may have caused a sell-down of global inventories instead. Easing monetary conditions may revert the trend, I speculated, turbocharged by inventories at historically low levels.
Well, I was wrong. We didn’t have to wait for easier financial conditions. The war Israel is waging on three fronts now ‒ against the Palestinians in Gaza and the West Bank, against the rabid Houthis in Yemen and Hezbollah in Lebanon ‒ will shortly engulf Iran. Discussed targets are Iran’s nuclear facilities, Iran’s leadership and the country’s oil export facilities.
While a loss of Iran’s (sanctioned) exports would remove 2% from global markets, a war theatre in the Hormuz Strait would incapacitate all Gulf shipments and reduce the world’s oil trade by nearly 30%.
The oil price, seemingly so oblivious to all tensions, had shortly lost its nerve. When Iran’s again well-in-advance-announced 180 rockets hit Israel on October 1, and a massive retaliatory action by Israel was firmly on the table, Brent oil prices shot up from $73.56 to $80.93 a barrel in six days.
When Iran reopened its air space for civil aviation again after a few nail-biting days, Brent slipped back to its previous slumber. It hovers in the $75 a barrel range at the time of writing. Markets, the events seem to tell us, are not about geopolitical tail-risk. But they do react when the gears jam.
The US administration’s desperate support of Israel, supplying state-of-the-art weapon systems, high-grade intelligence and active military support, is costly beyond its primary defence expenditure. It is paid with lost goodwill among partners, hostility in the Arab world and many Muslim countries in Africa and Asia. It is damaging traditional alliances and makes the circumvention of US sanctions morally rewarding.
The Netanyahu government’s unruliness comes with a loss of US respectability. The Biden administration acts like a parent capitulating to a truculent toddler: “Eat your broccoli. Please, have one, tiny stem. OK, at least look at the broccoli.”
What makes an all-out war with Iran, possibly engulfing the whole of the Middle East, almost unavoidable is, on one hand, Israel’s intention to decide domestic and external tensions with an all-out-war, substituting difficult compromise and risky, long-term solutions with the incessant drumbeat of destruction. It’s the angry toddler at work.
Iran too is cornered by indissoluble contradictions. A highly unpopular regime aiming for survival, it can neither risk to be seen as weak, nor accept the destabilising forces of open war with a strategically superior opponent.
This climate of senseless determination on both sides is the tinder for a convulsive escalation. We do not yet know how other US adversaries will take advantage of a wider war.
In the coming days, perhaps even while this text goes to print, the situation can cascade out of control. The oil price will spark, causing an inflationary impulse that will reach all parts of the economy. I think the US elections are too close now for such scenario to alter the odds for the presidential candidates. But it is certain that a suddenly higher oil price will boost Putin’s oil profits. Not only because earnings per barrel will increase but also because further sanction circumvention will be more widely condoned.
Shipments will increase in volume, not only to India and China, but will find their way into officially sanction-imposing countries. It is simply too costly for the West to make much of a fuss about it. Russia, like Iran, has grown a shadow fleet of oil and gas tankers that operate widely and with impunity.
Their modus operandi is well documented. Trading firms with shifting ownership-structures operate out of Dubai or other welcoming jurisdictions, handling a growing fleet of ships under changing names, changing flags and changing ownership. These vessels assume false identities and sail with shut-down, or obfuscating transponders.
Most ships are decrepit, badly maintained and insufficiently insured. Accidents are common, and the risk of serious, environmental damages to be paid for by suffering countries in the absence of responsible insurance cover is on the rise. Reloading at open sea, out of the legal reach of coastal waters, compound those risks.
Blending Russian oil into cargoes with more acceptable provenance has been developed into an art form. Distilling sanctioned crude into petrol and diesel to then be exported to Europe is common practice. Fake shipping documents (I have written about fake Libyan diesel exports recently) are hard to scrutinise or easy to ignore. Payment in gold, bitcoin or local currencies like the Turkish lira, renminbi or rupee bypass the policing of the banking system, and barter arrangements proliferate. Such nefarious activities will not only increase with a higher oil price, but be condoned.
Retail investors cannot easily place bets on geopolitical events. It is the domain of macro hedge funds and professional punters who often enough spectacularly fail. But as I have outlined earlier, the oil market is perhaps insouciant about the future, but tends to react to serious events with vigour. I still remember the sudden spike of the oil price when two planes hit New York’s World Trade Centre on September 11, 2001. Nobody knew what had really happened, but oil traders already laid their odds.
The shares of oil companies tend to follow the rise of crude prices quite closely. Looking at their share prices over time one can detect the narratives of the day: the reopening of China after the Covid lockdowns; the assault of Hamas on October 7, 2023, on Israel; the launch of the US military operation Prospering Guardian against the Houthi attacks in the Red Sea; Israel’s recent attack on Lebanon; or Iran’s second rocket attack on October 1. In each case, the oil price reacted, and so did the stocks of oil companies, despite their differing profiles.
Sure, company-specific circumstances may have an overriding impact. Whether Chevron’s takeover of Hess will include the new-found oil riches of Guyana, as adamantly opposed by Exxon, or not, will influence both companies’ shares. US-listed companies are usually more appreciated, which shows in higher price/earnings ratios. The success of trading operations and exposure to refining can have an impact. The outcome of the American presidential elections will be impactful too.
Compared with the returns of the S&P500, Big Oil fares poorly. BP has lost 18.41% per year to date, Chevron 6.24%, and Shell and Total hardly grew. But as a cautious hedge against geopolitical upheaval, oil shares do a pretty good job. If nothing else, oil companies are good dividend payers. I’d stay invested.
This is certainly not investment advice. Over the long term, oil investments will be shrinking businesses, akin to tobacco companies. They may feel morally wrong for many already now (I disputed this in an opinion piece). But they generate cash.
Andreas Weitzer is an independent journalist based in Malta.