Reed Between the Lines: Air Strikes & Oil Disruptions
By: J. Reed Murphy, CIO
Contributions by: Rob Young, CFA
Geopolitical risks appeared to be abating somewhat in recent weeks. However, with recent air strikes ordered by President Trump that killed one of Iran’s most powerful generals in Iran, geopolitical issues are now elevated. This has understandably grabbed headlines and the investor’s attention leaving many wondering what this means for the markets; particularly, the oil market. Any retaliatory actions that disrupt oil supply distribution could have far-reaching impacts, globally.
Revisiting Oil Supply Disruptions – 1970s Oil Embargo & 2019 Drone Strike in Saudi Arabia
Iran has actually been raising the stakes in recent months, including the alleged drone strike in September 2019, disrupting production at one of the world’s largest oil processing facilities in Saudi Arabia. The immediate market reaction was an increase in oil prices of 15% (Bloomberg, data from September 13th to September 16th). It caused many seasoned investors to recall the oil shortages during the 1970’s Oil Embargo days, which resulted in massive price increases in oil (~400%, according to the U.S. Office of The Historian) and long gas lines. However, the past was not an indicator for the future. By early October 2019, oil prices recovered and were trading at levels lower than they were just before the attack.
Exhibit 1: 2019 Drone Attack Proved Transitory
What Else is Important?
The broader immediate concern is that Iran could use its influence in the Middle East to disrupt the current supply of oil. Perhaps the most likely outcome could be a repeated attempt by Iran to block the Strait of Hormuz. The Energy Information Administration (EIA) describes the Strait of Hormuz as the world’s most important oil transit funnel as approximately 20% of the global oil supply travels through the strait daily.
What’s Different This Time?
What is critically different today -- and perhaps one reason that the oil market recovered this past September -- is that the U.S. is now a net exporter of oil and refined petroleum products AND the #1 global oil producer, surpassing both Russia and Saudi Arabia in recent years (according to the U.S. Energy Information Administration).
Exhibit 2: What’s Different? The U.S. is Energy Independent
Data as of December 2018. Source: EIA -- Oil and Other Liquids is defined as all petroleum including crude oil and products of petroleum refining, natural gas liquids, biofuels, and liquids derived from other hydrocarbon sources (including coal to liquids and gas to liquids).
Other Important Factors Going Forward?
With a potential escalation of military activities, we should also expect increased levels of market volatility. This scenario is something our investment team anticipates. And, it is why our portfolio construction has instruments in place, specifically to address this long- and short-term volatility.
As of now we remain focused on economic fundamentals. We note the following:
- Trade Policy & Tariffs – Progress is being made, creating less uncertainty and a spike in animal spirits.
- Global Monetary Policies (Central Bank Easing) – The vast majority of central banks have reversed course and are easing again after net raises in 2018.
- Global Fiscal Policies (Government Stimulus) – Governments are taking heed of central bank guidance, particularly the ECB, and starting to hit the fiscal pumps.
- Global Economic Bottoming – There appear to be many signs that economic softness is or has recently bottomed, which has aided the risk-on rally.
A review of our publication from late November, Storm Clouds & Turkeys provides relevant perspective to recent circumstances.
We continue to monitor events as they unfold. One area of particular attention will be to watch oil prices as they potentially increase. Despite U.S. energy independence, energy prices may increase over the short- to intermediate period. We will be watching to see if this stifles broader spending globally, noting that U.S. consumer spending has held up the U.S. economy. With WTI Crude trading at $63 per barrel on the morning of January 3, 2020, estimates are that pain could occur when oil hits the $80 per barrel price range.
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