INSIGHT: US-Iran tensions grow, crude markets unflustered

LONDON (ICIS)–Tensions continue to escalate between the US and Iran, with several large shippers reportedly halting traffic through the Strait of Hormuz but oil prices have failed to sustain spikes, although implications for petrochemicals remain substantial.

Crude prices have spiked several times in response to geopolitical shocks since the death of Iranian general Qasem Soleimani on Friday, jumping to over $71/bbl for Brent crude following news that Iranian forces had launched missile attacks on US bases in Iraq.

Global markets remain on high alert as rhetoric from Washington and Tehran continues to volley back and forth, but oil markets so far have largely failed to maintain the momentum of those tensions.

Spikes following Soleimani’s death and yesterday’s attacks quickly abated, with Brent dropping off around $2/bbl in afternoon trading from the morning’s highs, to slightly below $68/bbl a little after 14:00 GMT, not far above where prices had stood before the attack last week.

Brent crude movements Wednesday 8 January ($/bbl). Source: Reuters.

Even taking into account the news that certain key shipping players such as Bahri and Petrobras were temporarily suspending deliveries through the Strait of Hormuz, a crucial oil and petrochemicals artery through the Middle East, and French protests focusing on the country’s refineries, market oversupply remains the key factor.

“Market players calming down after the feeding frenzy as they await the next big chapter in the crisis seems to be the most immediate issue,” said Andrew Putwain, oil markets reporter at ICIS, “Constant oversupply has tamped down the extent of the response. Even with the French refinery blockades, Strait of Hormuz tensions and the introduction of stronger OPEC production cuts, the main feeling in the market is one of oversupply.”

This may also be a by-product of the sheer volume of political news in recent years, with the signal to noise ratio so weak among so many political and economic flashpoints that players have become more reticent about scrambling to respond to each incident.

Even drone attacks on Saudi Aramco infrastructure, the first missile attacks on the Kingdom since the Gulf War, sent brief ripples through crude markets before prices dropped back.

The weakness of the economy since mid-2018 and the growth of the US as a petro state has also insulated the duration of market shocks. The US-Iran conflict is extremely volatile and a move by either side that substantially disrupts the market could still serve to send oil prices soaring, but at present the market tendency is to remain below $70/bbl.

The oil price is not the only aspect of the crisis that petrochemicals players should be monitoring, as logistics is arguably the most pressing factor. Iran has threatened to block the Strait of Hormuz, which sees over half of global linear low-density polyethylene (LLDPE) exports pass by its banks.

The strait is vital for passage of a huge proportion of global chemicals trade as a gateway between the west and the east, and any long-term closure of the route in the event of all-out conflict in the Middle East could be disastrous for players and end markets across the world.

The question remains whether Iran would be able to close off the strait in the long-term if it decided to attempt that.

“Iran could close the Strait… but the US can force it open,” said a source with knowledge of the geopolitical conditions in the region. “The biggest threat to the Gulf in terms of the strait is if Iran mines it… [or] they probably deploy their four submarines, but they wouldn’t last very long in the face of an American naval operation. The US would not tolerate closure. In the short-term you’d get some disruption but not in the longer-term.”

IRAQ INSTABILITY
There are also implications on a longer timeframe if substantial quantities of oil are removed from the market, which would have a significant effect on petrochemicals production costs and margins.

Iraq, nominally an ally to both sides of the conflict and a key OPEC power, is finding its political footing, already unstable, to be increasingly precarious as the conflict escalates. Soleiman was killed on Iraqi soil, and the Iranian retaliatory strikes were focussed on US military bases in the country.

The country is also facing the threat of sanctions from the US after the Iraqi parliament voted unanimously to expel US troops stationed there.

The deposal of former ruler Saddam Hussein has led to a steady increase in Iranian influence in the country, according to the UK’s House of Commons, as the shift from a Sunni to Shiite-led administration resulted in greater philosophical alignment with Iran, which it has sought to cultivate.

“The overthrow of former Iraqi President Saddam Hussein is widely seen as a strategic gift to Iran,” said Ben Smith of UK state research organisation the House of Commons Library. “From a hostile, Sunni-led state, Iraq was converted into a Shiite-led country with natural affinities with Iran.”

“Since 2003, Iran’s influence in Iraq has steadily grown, particularly as western countries, especially the US, had reduced their presence,” he added.

Aside from fears of becoming the battleground for a proxy war between the US and Iran, Iraq’s political landscape is extremely unstable after the formal resignation of Prime Minister Adel Abdul Mahdi in December last year, and described by an analyst cited by UK state researchers as a “slowly failing” state.

Iraq was the second-largest OPEC crude producer by output in November, pumping out an average of 4.64m bbl/day during the month, and if external political tensions exacerbate instability in the country, the market could see a substantial player hamstrung at a time when oil prices are already rising.

Soleimani was understood to be involved in attempting to broker the formation of a new government, so his death could also have implications for those negotiations.

BYSTANDER EFFECT
Economists at think tank TS Lombard also point to the potential of “bystander effect”, where allies of either party could be caught in the crossfire, just as the countries worst-hit by the US-China trade war were Germany and emerging market economies.

With Iran likely to make life more difficult for US forces in Iraq and eastern Syria, its ties to Russia may mean that the eastern European giant may face additional sanctions as a result of that closeness, according to Christopher Granville, chief political economist at the firm.

“One of the more obvious political side-effects [of increased military or political aggression in Syria] would be to lower the bar to a renewed escalation in sanctions against Russia,” he said. “This conclusion about heightened sanctions risk does not depend on any assumptions about specific Russian action or inaction in response to the ‘Soleimani crisis’”.

“For both the Congress and the Trump administration it could well be enough that Iran is causing further US military casualties, and that Russia is aligned with Iran in the theatres concerned,” he added.

With the situation as febrile as it is, the situation could develop incredibly quickly in any direction. But with Iran keen to avoid a full-blown military conflict with a vastly more powerful rival, fallout could appear in the form of attacks on the strait, interference with allied powers, and intensified economic sanctions from the US.

Market players will need to stay abreast of developments and roll with the punches.

By Tom Brown

Click here to read more ICIS coverage of US-Iran developments.