Oil: Political markets have short legs

Oil: dipping below USD 60 as fears become fact

Norbert Rücker (Julius Baer) | Oil prices sold off more than 4% as concerns about supply risks in the Middle East calmed. The latest actions and reactions show that both opponents, the United States and Iran, are shying away from a military escalation out of fear of its potential economic costs. We stick to our Neutral view on oil and see oil prices lower towards year end. Demand should remain soft amidst weak growth, while supplies increase from Canada to the North Sea.

Political markets have short legs, as the saying goes. This holds true for commodities too. And these days, due to the escalation of tensions between the United States and Iran, the legs seem to be particularly short. Oil prices sold off more than 4% yesterday. Both Iran’s missile attack and the subsequent statements by the US administration lend support to the thinking that the opponents have little interest in a full-blown military escalation.

The missile attack on US-used air bases in Iraq seemingly balanced the need to deliver an immediate reaction without providing reasons for a further escalation of the conflict. These developments calmed concerns about supply disruption risks in the Middle East and pressured oil prices. Additional headwinds came from the weekly official oil-market statistics, which showed an unexpected increase in crude oil and oil-product stocks in the United States. Nevertheless, geopolitics and the Iran tensions will likely remain a source of market jitters going forward. However, the oil-shock risks should be put into perspective.

Various fundamental elements exist that would make such a spike short-lived. At above USD 70 per barrel, many emerging market economies would see demand suffering from high prices, amplified by the US dollar’s strength, while US shale oil output would begin to accelerate. At above USD 80 per barrel, developed-world oil demand would begin to deteriorate, while Asian buyers such as China and India would most likely loosen their compliance to Iran sanctions. At even higher levels, the world economy would teeter into a downturn. Exactly these inherent economic costs are a calming element within the conflict. We thus stick to our Neutral view. Rising supplies from Canada to the North Sea and soft demand should keep the oil market in balance and prices in check.