The cynic in me cannot help but wonder at the convenient turn of events over the past few weeks. The sorry saga began with the UK detaining a tanker carrying Iranian oil at the start of July, citing concerns the oil was destined for sanctioned Syria. Iran’s Revolutionary Guard has now, as expected, retaliated with last Friday’s seizure of the Stena Impero, a British oil tanker. Consequently, the USA and UK are mobilising a large fleet of naval hardware into the area around the Strait of Hormuz to protect shipping carrying a fifth of the world’s oil to market.
Donald Trump has been escalating pressure on Iran, having abandoned the nuclear deal brokered with Iran in 2015. With the support of John Bolton, White House national security advisor and notorious Iraq-era hawk, they have applied substantial pressure on Iran, radicalising the most moderate Iranians. Britain seems to be the unwitting pawn in Washington’s game of high stakes poker in the region.
Importance of the Strait
The Strait of Hormuz is twenty one nautical miles long, stretching between the Persian Gulf and the Gulf of Oman, and constricting the international shipping lane to just two miles in either direction at its narrowest point. OPEC members Saudi Arabia, Iran, the UAE, Kuwait and Iraq export most of their crude via this strait. Approximately 17.4 million barrels a day make their way through this critical choke point.
Oil price reaction
Oil prices have begun to advance following these developments but have been slow to build in any significant risk premium into either the spot or forward market. The Nymex Oil Volatility Index rose to its highest level in two weeks on Friday, but oil price direction remains uncertain as global growth concerns and trade war pressures continue to cloud the outlook. Brent crude prices remain modestly backwardated this morning, as does ICE Gasoil.
US shale continues to dominate
US shale production continues to confound efforts by OPEC and Russia to boost crude prices and has resulted in the USA eclipsing both Russia and Saudi Arabia as the world’s largest oil producer, producing a whopping 15.3 million barrels per day (bpd) in 2018. Saudi Arabia came in second at 12.3 million bpd and Russia third at 11.4 million bpd.
Iran has a lot at stake with revenue losses per day from oil sanctions estimated to be $130 million, as well as Saudi Arabia lining up to sign long-term supply agreements with Iranian clients. This places Iran in somewhat of a quandary. They need to appear strong to their population but cannot sustain the economic pressure indefinitely. If the Iranian government decides to face down the joint naval fleets of the USA and UK, the risk of a third Gulf War becomes increasingly likely. Not only will this be devastating from a humanitarian perspective, it will drive oil prices substantially higher at a time of weak growth prospects from both developed and emerging markets.
Emerging market vulnerability
Emerging markets are arguably the most vulnerable to a third Gulf conflict, with the majority being net importers of oil. Furthermore, their currencies will suffer, as the market will undoubtedly switch to a risk-off stance, selling EM assets and buying USD safe haven assets. With regards to the US, expect further bouts of USD strength. Quite where GBP will end up is anyone’s guess, with a new, untested PM imminent, Brexit Halloween looming, and further military entanglement in the Gulf a growing possibility.
Upcoming Economic Releases
The week ahead has a number of key releases, not least of which is Robert Mueller’s testimony to congressional lawmakers regarding possible Russian interference in the 2016 US presidential election.
The ECB is to provide forward guidance on further stimulus packages and signal when to expect additional rate cuts. This is likely to drive Bunds to even lower yields.
The UK will discover who their next Prime Minister is on Tuesday, with the reins expected to be handed over on Wednesday afternoon.
For more information, please contact Lionel Kruger, Director at JCRA, at firstname.lastname@example.org.