Energy Prices and Middle East Unrest

Jan 14, 2020

If you have been anywhere near a newspaper or television set in the last week, you have undoubtedly seen or heard about the U.S. drone attack that killed a high-level Iranian military commander. Some have even suggested that General Qasem Soleimani was the second in command for Iran, and his absence could have a significant impact on the regime.

Some wondered if this was an attempt by U.S. President Donald Trump to shift attention away from the impeachment hearings or was a move that was well thought out before being acted upon. Whatever the case may be, it is now done, and Iran already staged a retaliatory strike last week by firing over a dozen missiles at U.S. troops stationed in Iraq. Fortunately, it has been widely reported that no U.S. soldiers were affected by the missile attack.

Iran is a major crude oil producer and sits on top of a massive oil inventory. Crude oil for March delivery, the front-month contract, did see a spike to over $65 per barrel after news of the missile attack broke. As has been seen many times before in energy markets however, a quick calming of the situation has brought prices right back down to below previous levels. March crude is currently trading for less than $60 per barrel as calmer heads have thus far prevailed. In fact, March crude is down about 10 percent from its high reached last week in a short period of time, showing just how fragile energies can be in the face of geopolitical factors.

Make no mistake though, crude oil prices could potentially see a substantial rise if the U.S./Iranian conflict continues. Although any sharp, rapid rises in oil prices may not be sustainable, the market could become quite vulnerable to high levels of volatility. The New Year could see significantly higher energy market volatility compared to recent years, and oil could find itself trading back at $80 or even $100 per barrel if the conflict escalates further. Although higher oil prices may be good for oil stocks, they are not a positive for the economy. Sharply higher crude oil could effectively weigh on the global economy, which is already under a large amount of duress, pushing the globe into the next major recession. Global central banks have already begun easing again in order to prevent the next recession, and further easing will likely be required to keep the global economy from shrinking further. As a dollar-denominated commodity, oil could also stand to possibly benefit from a weaker dollar if the U.S. Fed is forced to cut rates further or begins a fresh round of quantitative easing.

Of course, oil is not the only energy product that could be affected. Gasoline prices, for example, could also stand to see a sharp rise in volatility and could even spike in value if the conflict escalates further. Like crude, however, any sharp rises in gas prices may prove to be short lived, as demand could see a dramatic decline.

We are doubtful that any sustainable ascent will be seen in energy this year due to the U.S./Iranian conflict. Despite the current heightened state of geopolitical risk, there are also a variety of factors working against energies currently that may keep a lid on prices. That being said, an increase in overall energy market volatility does seem likely and investors may want to keep higher volatility in mind when considering positions.

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