Middle Eastern politics begin to affect oil prices again

Adam Feik - INO.com Contributor - Energies

For months, the big story behind plummeting oil & gas prices has been the U.S. and Canadian on-shore shale boom. The resulting supply glut has caused WTI crude to fall from about $107 on June 20th, to a low of about $45 recently. Meanwhile, Saudi Arabia and OPEC have held firm to their Thanksgiving weekend decision to continue pumping at a steady rate. Finally, lackluster demand from emerging countries like China hasn't had enough kick to cause prices to rebound significantly.

So… OPEC countries have been the "steady" ones in all this.

In recent days, however, focus has turned to the Middle East (of all places). Can you imagine? Middle Eastern geopolitics affecting oil prices? It's been awhile since the Mid-East has been the center of attention.

Today, two major developments are in the spotlight; namely, Saudi Arabia's military action in Yemen, and the Iran nuclear talks.

Conflict in Yemen

Last week, Saudi Arabia launched air strikes against rebels attempting to increase their power in the government of neighboring Yemen. This conflict has the worrisome potential of escalating into a full-on regional war between Sunni and Shia Muslim factions – which could spiral into a wide-ranging war without borders.

Saudi Arabia, a Sunni nation, has become virtually surrounded by Shiite enemies, many of whom are backed by Iran. Of course, the Middle East/North Africa region produces about one-third of the world's petroleum (at around 30 million barrels per day), according to data from the U.S. Energy Information Administration at EIA.gov. Historically, episodes of instability in the Mid-East have often added a "geopolitical risk premium" to oil prices.

This Sunni vs. Shia conflict has the potential to continue indefinitely, adding a risk premium to oil prices for a long time. Oil prices jumped 5% last Thursday alone, the day the airstrikes began. Since then, oil has shed about 7% over the 3-day period leading up to today's deadline in the Iran nuclear talks. Which brings me to the second issue.

Iranian nuclear deal

As I write this, negotiators have once again, moments ago, failed to reach the framework of a deal to end sanctions on Iran in return for cuts to the Iranian nuclear program. The so-called "P5+1" nations (U.S., Britain, France, Germany, Russia, and China) have apparently so far been unable to overcome obstacles to reaching an understanding with Iran’s negotiators. However, all parties are vowing to continue the talks. This marks the third time talks have been extended.

Should an agreement eventually be reached, Iran has the potential to bring more oil production onto the world’s markets. Estimates range from 500,000 barrels per day within 6 months, to 1.2 million within 18 months.

In terms of impact on oil prices, of course, these talks have been a well-known issue for several months, and oil markets seem to have spent the last few days specifically pricing in the possibility of a deal (as mentioned earlier).

Of course, today's deadline was simply to achieve the "framework" for a deal. The deadline to finalize the specifics comes at the end of June. In any event, any increased flow of Iranian oil to global markets is probably at least a few months out, but markets are already trying to figure out how to price in whatever is going to eventually happen.

This uncertainty may contribute to some near-term volatility, although probably modest. An earlier nuclear deal between Iran and the P5+1 countries in late-November 2013 caused only a slight wiggle in oil prices, which fell only about 3% over the ensuing 3 days. The 2013 deal didn't remove sanctions on Iran but, was viewed as symbolic of further progress yet to come. See this CNBC article from 11/24/2013 for more.


In the near-term, none of this is likely to kick oil prices out of a certain range, in my view.

The Iranian talks still seem to be headed toward an eventual end to sanctions, whether in stages or all at once. If that should occur, the additional 1 million barrels or so of Iranian production will come online again at some point. Information will trickle in gradually, in spurts over a period of months, but the added supply won't shock or surprise markets. The near-term result could be a temporary $5 per barrel fluctuation, at most, in my view.

As for the Middle Eastern conflict, a worst-case scenario would be, of course, nothing any of us ever want to think about. If the conflict escalates into a long, drawn-out war (which seems to be a real possibility), the Mid-East "risk premium" may materialize again and remain in place for a long time. Of course, higher oil prices might be the least of our worries in such a nightmarish state of affairs. At any rate, markets are certainly not pricing in anything of the sort, as of this writing. Stay tuned.

In the meantime, I expect oil prices to be driven primarily by the same supply-and-demand factors that have reigned since last June.

Adam Feik
INO.com Contributor - Energies

Disclosure: This contributor does not own any stocks mentioned in this article. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.