By Julianne Geiger
- OPEC’s decision to curtail production has created an even tighter oil market.
- Oil markets are growing more vulnerable to supply outages.
- Geopolitical risk in oil markets is growing in 2023.
Oil markets are becoming increasingly sensitive to geopolitical events in recent months, with major price rallies manifesting even for a relatively small cut in production, especially when there is geopolitical context to add more uncertainty to the mix.
The already tight oil market was squeezed even further over the weekend, when OPEC+ made its surprise announcement that it would make a further 1.6 million bpd cut to production to balance things out.
That supply and demand balance is so precise now that the market is having outsized reactions to geopolitical developments, such as the halt to Kurdish oil exports from northern Iraq to Turkey last week as the result of an international arbitration ruling in the Iraqi federal government’s favor.
That took 450,000 barrels of oil exports offline, leading to a major oil price rally. If the markets thought things were tight last week, though, the surprise move by OPEC+ pushed prices up another 6-8% in the following days. The market is now performing its balancing act on a tightrope that can be undermined by less-than-major geopolitical events.
The Venues and Incidents that Could Easily Drive Oil Higher
Libya
Suddenly, everyone will be watching. Even at the height of the post-Gaddafi civil war, when Libyan National Army (LNA) strongman General Haftar blockaded Libya’s some 2 million bpd of oil–a feat he managed for over two years–the markets rarely blinked. Now, with that oil pumping again and working its way back up towards 2 million bpd (from around 1.2M presently), it won’t be 2 million barrels that violently pushes the oil price needle–a mere fraction of that would do the trick.
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Exploration and expansion deals foreign companies are feeling brave enough to invest in right now in Libya are tenuous, at best. If the relationship between Iraq proper and the Kurdistan Region of Iraq in the north is seen as volatile, Libya is far more vulnerable to bigger disruption. That will be the case until elections can be held. Elections won’t be held until a certain amount of additional inter-faction deal-making has been done and that everyone gets a sizable share of the oil resource pie. Until then, chaos is the governor and oil should be watching developments on a daily basis.
Israel, Iran & the GCC
Saudi Arabia and Iran have now restored diplomatic ties and entered a phase of rapprochement that is intended to ease the pain of the proxy war in Yemen and, for oil markets, to reduce the potential for another Iranian attack on Saudi Aramco facilities–an event that would completely rock the markets. Despite the enormity of that same event back in September 2019, oil markets only responded briefly (and explosively, 20%) but only held those gains for a short period, with Brent range bound in the low $70 soon enough. There was a lot of oversupply at that time. Ten days after the attack, Aramco had its damaged facilities back online and oil prices pared most gains.
It won’t happen like that this time. A similar event would easily push Brent to (or even over) the $100 mark. (Then inflation fears explode and the Fed steps in with another hefty interest rate hike and we come full circle).
In the meantime, while the normalization of ties between the UAE and Israel bode extremely well for the region, the Saudis have not been keen to make this same move–yet. And now Israel has been wrongfooted by the Saudi-Iran detente, which is one of Tel Aviv’s biggest nightmares. Having Iran as an enemy was the only clear item on both the Saudi and Israeli agendas. (Right now, Israel is most likely wondering what will happen in light of the detente if it launched another covert attack on Iranian nuclear facilities).
Additionally, with Benjamin Netanyahu now back in the PM’s seat in Tel Aviv, and as radical and contentious as ever, no other Gulf states would think of entertaining normalization. Potential Israeli actions are now one of the more extreme levers of vulnerability in the region.
Iraq & Iraqi Kurdistan
This is an old, long-running narrative that the markets have largely ignored until now. Iraqi Kurdistan has unilateral deals with foreign oil companies that are pumping oil on territory governed by the Kurdistan Regional Government (KRG), a semi-autonomous region that still relies on disbursements from the Iraqi federal government.
Baghdad’s grievances are, of course, understandable to some extent. All the oil from all of Iraq is meant to be sold by the federal government’s state-run marketer, SOMO. However, for years, the KRG has been selling its oil directly to markets by piping it to Turkey, bypassing Baghdad’s coffers. For years, no legal battles, threats, etc had managed to disrupt Kurdish oil … until last week, when an international court ruled in favor of Iraq against Turkey, prompting Turkey to shut down the pipeline and remove 450,000 bpd from the market.
On Monday, Baghdad and Erbil announced they had reached a preliminary agreement that could get the oil flowing this week. Just a day later, on Tuesday, Baghdad and Erbil signed the above-mentioned deal, calling it a “temporary” move until the Federal budget is worked out. That was implemented on Wednesday morning, with flows restored. The battle between Baghdad and Erbil is still far from over, and any similarly high-level events in the near future could result in another sharp oil price rally.
Russia & Ukraine
The market hasn’t reacted as much to Russia’s announcement that it will extend its 500,000 bpd production cut through the end of the year. That is not to say there was no reaction; however, it came wrapped up in the surprise OPEC+ output cut decision, so it was really a package deal. Additionally, it was this Russian output cut (priced in because it was announced in advance) in combination with the timing of the loss of Kurdistan’s 450,000 bpd that drove prices higher.
While the market is already aware that this is going to be a long war (which has already entered its second year, anyway), major developments such as the use of tactical nuclear weapons on Ukraine that would bring us close to more active NATO involvement (and thus WWIII), do not even bear speaking about. We will be beyond discussing oil prices at that point.
What about China?
China is the demand key, but the recovery is gradual and frequent data releases only offer us glimpses of potential demand–not likely enough to move the needle as drastically as one of the above geopolitical developments.
On a geopolitical level, while the U.S. has largely come around to the notion that Beijing is its biggest threat and its most formidable enemy, we are not at this time in a situation in which a direct geopolitical event is likely to emerge to roil oil markets. That is, however, our future.
In this atmosphere of extreme sensitivity to supply, a geopolitical event that takes the markets by surprise will have the most significant price impact. NB: Julianne Geiger wrote this article for Oilprice.com
