May 02, 2019

Outguessing Oil Brinksmanship

Oil prices are hovering near six-month highs at around $63 per barrel for the benchmark West Texas Intermediate crude. Those in the market to trade energy contracts are about to witness a game of multi-dimensional oil market chess and the outcome will help drive the narrative of the global economy for months.

The opening move was the recent announcement from the Trump administration that waivers previously granted to countries that wanted to import oil from Iran would be zeroed out.

Last May, when President Trump pulled out of the Iran nuclear deal, the administration warned that countries that continued to buy Iranian oil faced sanctions from the U.S., such as being denied critical access to U.S. capital markets.

Last October, markets pushed prices higher, expecting a sharp drop in supply based on the loss of Iranian oil exports. Traders were then a bit surprised with the waivers granted eight countries by the U.S. to continue to import Iranian crude and subsequent jump in supply, which pushed oil prices down to as low as $45 a barrel in late December.

Now, with the decision to end those waivers on May 2, markets are trying to anticipate two questions: how much Iranian oil will be pulled from the market and who, if anyone, will make up the difference? Our parent company, Royal Bank of Canada, expects that Iran's supply will drop 700,000 to 800,000 barrels per day – enough to push up prices on its own.

Clearly, oil price escalation is not something this administration wants. Markets expect that more U.S. shale production, along with greater output from Saudi Arabia and the United Arab Emirates, will make up the supply difference.

Yet that is not guaranteed. The relationship with Saudi Arabia is particularly shaky after the diplomatic uproar over the killing of dissident Saudi journalist Jamal Khashoggi last October by agents of the Saudi government.

At the same time, Venezuela is again in the news, with opposition leader Juan Guaido pressing the military to side with him against embattled President Nicolas Maduro. The U.S. is not currently taking Venezuelan oil. But if that situation turns then there is another player in the mix.

My View: The Khashoggi affair seems like ancient history right now. The merits of that aside, clearly the energy market is back to a “Game of Thrones" world that is reacting to geopolitical scheming rather than pure economics. RBC calls this “oil brinksmanship." Should be interesting.

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