ANALYSIS: Double-whammy of Middle East geopolitics may fuel oil-price rally

A double-whammy of Middle East geopolitics threatens to propel oil prices higher.

The first whammy is the growing military conflict between Iraqi forces and the Kurds that may interrupt energy supplies.

A second punch revolves around increasing tensions between the Trump administration and the Islamic Republic of Iran. It may lead to the reintroduction of harsh US sanctions, including a ban on buying Iranian crude oil.

“You are finally starting to see geopolitical factors impacting oil prices,” says senior energy policy analyst at Hedgeye in Washington, DC and former chief of staff at the US Department of Energy.

Futures prices for light sweet crude were recently trading for around $52 a barrel on the Chicago Mercantile Exchange (CME), which is noticeably up from as low as $26 in early 2016.

Skirmishes between Iraq forces and Kurds

The first issue for the oil market is what may happen between the Iraqis and the Kurds, now that the Islamic State (IS) group is close to being expelled from Syria and Iraq.

The Kurds have long desired their own independent homeland from Iraq, Syria and Turkey. As shown by Iraq’s takeover of oil-rich Kirkuk last week, existing countries have expressed a desire to maintain their control of territory especially where there are oil riches to be had.

Iraq produced approximately 4.4m barrels of oil a day in 2016, according to the US Energy Information Administration.

That makes the country the sixth largest producer in the world, behind Canada but slightly ahead of Iran.

The problem is that the to-and-fro between Iraq and the Kurds isn’t likely to settle down anytime soon.

“A stable new equilibrium is unlikely to emerge quickly,” states a recent report from Eurasia Group, ominously titled “IRAQ – New round of escalation looms.”

“The Iraqi government and Massoud Barzani’s Kurdistan Democratic Party (KDP) do not appear to be moving toward a compromise, especially given Baghdad’s intention to expand its control of Kurdish territory,” the report continues.

Eurasia Group reports as recently as “the last few days” say that there have been intensifying military clashes between Iraqi forces and the military wing of the KDP. Neither side looks ready to back down.

Of the two sides, Iraq looks far stronger militarily and the broader Kurdish faction is divided politically.

Although the Kurds are currently on the retreat and have made moves to negotiate a way out of the crisis, more skirmishes seem likely.

While the oil market doesn’t focus on only military action, traders do get concerned when there is an increased likelihood of interrupting energy supplies. That seems more than possible for the immediate future, experts told Middle East Eye.

“Conflict and tension will go on for an indefinite period of time and it will disrupt and disturb oil production,” says Larry Goldstein, director of the Washington, DC-based Energy Policy Research Foundation Inc (EPRINC).

When oil supplies get interrupted, prices jump because the energy market is finely balanced, so even small changes can make a big difference in the futures markets. 

US edges closer to sanctions on Iran

Meanwhile, new US sanctions against Iran (specifically towards the Revolutionary Guard) have been imposed and other trade penalties with a larger economic bite remain more than a possibility within approximately “two-to-three months” from now, according to a recently published report.

“We believe US sanctions on Iran’s crude exports, as well as insurance and shipping sanctions, are likely to be reimposed in early 2018,” states the report from US financial firm Hedgeye.

Such sanctions would have a profound impact on global oil prices as Iran has added approximately 1m barrels a day of crude oil to the world market since the sanctions were lifted under President Obama last year, Hedgeye says.

Even if only Washington implements sanctions, it is likely that European companies that trade with the United States would stop dealing with Iran. The net result: futures prices for light sweet crude could surge above $60 a barrel.

The move toward tougher sanctions comes after President Trump’s refusal to certify Iran’s compliance with the deal that was meant to limit that country’s access to atomic weapons. In late September, Middle East Eye highlighted that such decertification would be highly likely.

The main reason Hedgeye sees sanctions as pretty much inevitable is Iran looks “unlikely to negotiate or make any concessions,” the report says. And it is renegotiation that Trump is aiming for in this instance.

Even though the administration hasn’t managed to push legislation through Congress, Trump pledged to scrap the deal before he was elected and is unlikely to back down.

Some mitigating news on the way

Higher energy prices might be great for big energy exporters such as Saudi Arabia, but they don’t exactly help the larger industrialised economies of Western Europe and North America. An increase in gasoline prices in the US acts like an additional tax and reduces the spending power of consumers, thereby tempering GDP growth.

And that’s where there's a modicum of good news.

In the US, production of crude oil and natural gas liquids should add the equivalent of around 1m barrels of oil a day in 2018, says EPRINC’s Goldstein. He explains that producers who focus on extracting oil trapped in shale deposits have already fixed the prices of next year’s energy production. This is known in financial circles as hedging.

“Producers know that what they are producing next year is sold,” says Goldstein. “They already got their money.”

That means the US shale-oil drillers will deliver the extra supply whether or not the futures markets prices decline. That will moderate any losses from either sanctions or supply interruptions in Iraq due to military conflict.

Still, if the US does slap sanctions on Iran, and the fighting between the Kurds and Iraqi forces does interrupt oil supplies, it would be hard not to see crude prices jump higher in short order.

This article is available in French on Middle East Eye French.