A couple of days ago, we posted something called “The Saudi Purge: What Are The Implications For Oil?”
Yes, “what are the implications for oil?” That’s a good question, and it’s one a lot of people are still trying to answer. The gist of that post was that you can’t really try and separate the Saudi purge from escalating tensions between Riyadh and Tehran. And you certainly can’t separate those tensions from the proxy wars in Yemen and Syria. There were two events over the weekend with direct implications for those wars: flying Houthi missiles and the resignation of Saad Hariri in Lebanon, with the latter event clearly designed to aggravate Hezbollah whose efforts to prop up Assad in Syria have bolstered the group’s reputation (although “reputation” might be something of a misnomer there). Here’s WaPo on Lebanon:
The Israelis seem ready to fight Hezbollah, the Saudis are eager to use Lebanon as a battleground to deliver a blow to Iran, and the Americans want to curtail Iran’s influence through economic sanctions against its proxies. Hariri’s abrupt resignation in effect denies Hezbollah a strong Sunni partner and an effective cross-sectarian National Unity government.
So when you think about the implications for oil, this is a little more straightforward than a lot of people seem inclined to believe – or at least in the near-term. MbS supports the production cuts and is a foreign policy hawk. Taken at face value, that combination should be bullish.
Throw in the fact that MbS has the opportunity to curry favor with the Trump administration by taking a hyper-aggressive approach to curbing Iranian influence, and one would be inclined to believe that we’re in for a prolonged period of rising tensions.
Ok, so Goldman is out on Thursday taking a stab at documenting what they’re calling “a sudden further rise in geopolitical tensions,” and while I most assuredly do not agree with the use of the term “unrelated” in what you’ll read below, this is at least a handy summary of recent events, events which, don’t forget, include a truly ridiculous debt “restructuring” effort in Venezuela (and the scare quotes are there for a reason). Here are Goldman’s bullet points…
Geopolitical oil tensions have increased sharply over the past month, first in Iraq and Iran in early October and over the weekend with further escalations in Saudi Arabia, Iran, Venezuela and Nigeria. Relative to the past couple of years, the most significant escalation in geopolitical risks came over the weekend from Saudi Arabia where two unrelated sets of events occurred: a rise in tensions with Iran and a wave of political arrests.
- Saudi Arabia qualified as potential “acts of aggression” instigated by Iran both a missile attack launched from Yemen and the resignation of Lebanon’s prime minister. Tensions with Iran have come on the heels of President’s Trump decision to decertify the lift of nuclear sanctions and the US administration imposing unilateral secondary sanctions against Iran entities. The risks to the oil market are either an escalation between these two countries that would affect oil producing assets or additional US secondary sanctions targeting Iranian oil exports, with President Trump voicing his support for Saudi Arabia following the events of the past weekend. As we have previously discussed, the latter would initially put at risk a few hundred thousand barrels of Iranian exports.
- However, it is important to highlight that historically, OPEC’s oil collaboration has prevailed even in periods of member conflicts such as the Iraq wars. In this case, Iran’s request to be granted room to grow production was accommodated last November, even as tensions were already rising. As a result, although risks have increased, we do not assume that the most recent escalation will impact oil flows from these countries through either disruptions or OPEC dissent.
- These new tensions occurred concurrently to an unrelated wave of political arrests in Saudi Arabia, driven by an anti-corruption push. According to media reports, this has left the crown prince in charge of the military, internal security services, and national guard, marking a break with the historical political power sharing by the royal family. From an oil market perspective, the risk is that such a shift creates medium term political instability within the kingdom that would threaten oil production. In Iraq, the conflict in Kurdistan has similarly threatened the country’s medium term political stability and the lack of quick resolution to the shift in control of oil assets creates the risk that Northern Iraq production remains below our 0.6 mb/d expectation in 2018.
- Last Thursday, Venezuelan president Maduro announced that the country would ‘refinance and restructure’ its foreign obligations. While we take no view of whether Venezuela could default, this announcement has increased the risk that production declines exceed our -165 kb/d forecast from 4Q17 to 4Q18. A default would not imply a sharp drop in production as the marginal heavy oil barrel still generates free cash flow at $50/bbl. However, it would raise logistical risks to oil exports as well as potentially generating risk aversion by purchasers as well as higher oil service costs. The decline in production has in fact already accelerated with October output at 1.88 mb/d, down 150 kb/d since the beginning of the year, and the oil rig count falling to 39, its lowest level in 14 years.
- Finally, the Niger Delta Avengers rebel group in Nigeria, which was responsible for the attacks on oil infrastructures in 2016, announced that it was ending its ceasefire and would resume attacks, which could threaten the 0.4 mb/d recovery in local oil production since the summer.
So one question you might fairly ask here is whether between everything said above (on the bullish side) and the very real possibility that OPEC could screw up the messaging which, in combination with still resilient U.S. production, could make for a compelling bear case, short-dated oil implied volatility is too low: