Geopolitical Risk Returns
With the first quarter now behind us, it is an opportune time to review the global energy markets and assess the underlying forces moving prices. During the first quarter, crude oil traded in a fairly narrow range. In the recent weeks, however, crude prices have broken from this pattern and spiked upward due to increased geopolitical tensions. The recent price spike has gained a great deal of attention and merits a comprehensive examination.
Throughout much of the first quarter trading in the international energy markets was fairly sedate – WTI traded between $60-65 and Brent between $65-70 per barrel. The underlying market driver was the extension of the OPEC/NOPEC agreement continuing the stated 1.8 mb/d in production cuts through the conclusion of 2018. Traders were therefore largely focused on US crude oil inventories and production levels to assess the extent to which the global crude market has rebalanced.
In the recent days this situation has changed drastically. As opposed to being concerned about market rebalancing, traders have turned their full attention back to geopolitical risk. The trigger for this change in focus was the alleged use of chemical weapons by the Assad regime against of the remaining pockets of Syrian rebel forces (Douma). Any use, or alleged use, of chemical weapons understandably sets off alarm bells within the international community of nations and in the past days the US, as well as several allies, have stated that such an appalling event will not go unanswered. In the ensuing days, as one would expect, there has been a significant degree of posturing in the United Nations by members of the Security Council but no clear response of action has been agreed. President Trump announced that the US military will take action in response to the alleged chemical attacks culminating in a tweet this morning warning Russia that the US would soon be launching a strike against Syria and Assad’s military forces. In response to the US warning of an imminent strike, Russia responded by stating that it would intercept any missiles fired by the US at Syria and would strike launch sites if Russian lives were threatened. Clearly the markets are unhappy with this reckless war of words between superpowers and its potential consequences in this already unstable region.
As the world waits for the US to launch its response against Syria, the energy markets have been pricing in this heightened geopolitical risk of an event impacting the international energy markets. In the past three days WTI and Brent have increased approximately $5 each and currently trade above $61 and $72 respectively – representing three-year highs. The unknown that the markets appear to be most concerned about is the risk of escalation – Syria represents a flashpoint with Russia and Iran on one side and the US and Israel on the other. Any irrational escalation of events or an inadvertent incident would indeed have potentially serious consequences. It is important to note that Israel has launched multiple pinpoint military strikes into Syria over the past months to reduce what it considered to be threats posed against Israel (e.g., the launching of drones from Syria into Israeli territories). Those strikes indicate that the situation on the ground has been growing more fragile over the past weeks/months.
Despite the recent sharp increase in the price of crude oil to-date, it is important to note that not a single barrel of production or shipment has yet to be impacted by the increased tensions. The recent rise in pricing has been the traders front-running the potential risk of events escalating and affecting the broader region. There can be little doubt that at present the prospect for diplomatic initiatives between all the parties do not appear promising – President Trump himself stated today that relations between the US and Russia has sunk to a level not seen since the Cold War. However, one must believe that the prospect of reigniting wider conflict in the Middle East is so disagreeable that the parties will ultimately make every effort to find a diplomatic solution.
While these events are playing out we expect price volatility to accelerate as every tweet (or statement) and response either heighten or assuage market anxiety. In the event cooler heads prevail, we expect the recent increase in prices to drain from the market quickly as traders will go back to focusing on US weekly inventories and production figures until the next OPEC meeting. If, however, the situation does escalate, then markets will focus on the actual geopolitical event and specifically its potential impact on international crude production and transport.
We will be watching the situation closely and provide further commentary.