Oil markets absorbed US President Donald Trump’s decision to withdraw the US from the Iran deal without a huge shock last week. Brent crude jumped from around $74 to $77 a barrel, after the president chose one of the harsher of the options that were available to him.
But Trump’s decision could hardly have been a surprise. The bigger shock is yet to come – but markets are remarkably sanguine about it.
It’s been a while since oil prices jumped around purely on the basis of geopolitics. Over the last five years, market watchers have focused instead on the tug of war playing out between US shale producers, who keep surprising the world with their adaptability, and Opec, which finally managed to agree on production cuts last year and has largely stuck to them. As a result of Opec’s renewed discipline, Brent crude has risen steadily from US$50 a barrel to around US$75 in the past 12 months.
Opec needed to do something. Ever since US shale producers burst on to the scene in 2014, the cartel had struggled to cope.
Saudi Arabia decided it was a good idea to give the Americans “a good sweating” by stepping up production and cutting prices.
At the time, US shale was high cost and looked fragile. I remember former BP boss Tony Hayward telling me confidently in 2013, when Brent traded at over $100 a barrel, that $50 oil would wipe out much of the burgeoning American oil industry and send prices right back up again.
But against expectations, the shale producers knuckled down and slashed costs.
The direct effect of his Iran decision is fairly negligible. Iran still hadn’t managed to boost its presence in oil markets massively even after the deal came into effect. Even with the US sanctions back on, it will still be able to sell its oil to Asian markets.
The international investment it needs to raise its production significantly in the long-term has been slow in coming, precisely because of the geopolitical risks.
But the knock-on effects could be significant. The White House, sensitive to the impact that any oil price spike could have on US consumers, especially ahead of the midterm elections, claimed that it had assurances from friendly producers that they would make up for the shortfall caused by Iran. This is a short-term solution.
For one thing, it isn’t in the interests of Opec producers to dampen down prices by much.
Saudi Arabia might want to help out the US and be supportive of Trump’s tough stance against Iran. But it also needs oil to go higher to pay for its enormous economic reform programme and to ensure it gets a good valuation when it floats Saudi Aramco, a deal now slated for next year. The rumour mill has it that Riyadh wants to see prices stay up around US$80 a barrel. If that’s the case, it’s unlikely to be arguing for Opec to change course.