Geopolitical risk may be the factor to watch in 2018 for oil

With the surplus that pushed oil prices below $30 per barrel in 2015 all but gone, markets have little room for luxuries like unrest or belligerence.
By Daniel J. Graeber  |  Jan. 2, 2018 at 9:25 AM
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Jan. 2 (UPI) -- A U.S. president eager to advance an agenda of energy dominance, and a market with no room for risk, means 2018 may be one for the geopolitical books.

The New Year started with Iran in the grips of one of its worst bouts of political unrest since the Green Revolution in 2009 brought the first glimpses of a challenge to the cleric-backed regime. On Thursday, hundreds of protesters gathered in Mashhad, the country's second-largest city by population, to chant slogans against rising prices in the Islamic Republic. By the weekend, those protests had turned violent and deadly.

As the unrest escalated, Eshaq Jahangiri, one of the country's vice presidents, said Thursday he felt the economy was "on a good trend" and inflation, while high, was under control. According to the International Monetary Fund, growth in gross domestic product for Iran should be around 4.2 percent, though a rate of inflation close to 10 percent is problematic for one of the world's top oil producers.

Addressing the mounting frustrations on the street, Iranian President Hassan Rouhani acknowledged Monday that while sanctions relief since the implementation of the U.N.-backed nuclear agreement in 2015 had contributed to growth, it was not enough.

"People have problems and these problems must be solved," he was quoted by the Iranian Students' News Agency as saying.

Iran is one of the top producers in the Organization of Petroleum Exporting Countries. Total receipts from the export of oil products and natural gas condensate were $2.5 billion over the last seven months, a 41 percent improvement over the same period during the previous year. By November, the country was producing around 3.8 million barrels of oil per day, an uptick from the bottoming out of 3 million barrels per day before the U.N. deal.

Joe McMonigle, a senior energy analyst at Hedgeye Risk Management, said Iran could be facing further external pressures this year from U.S. President Donald Trump, who as a candidate threatened to rip up the nuclear agreement.

"Oil markets could see a few geopolitical lottery tickets in 2018 if Trump, as I expect, nixes the Iran nuclear deal by re-imposing oil sanctions," he told UPI.

In neighboring Iraq, also one of OPEC's top players, hundreds of thousands of barrels of oil were caught in the crossfire in October as rival forces fought for control over the disputed northern city of Kirkuk. Though there were competing narratives over the flow of oil, the federal government made it clear it would be the Iraqi flag that flew over the area.

Trump by then had already threatened to unravel the Iranian nuclear agreement, something McMonigle said could put about 1 million barrels of Iranian oil out of the market. That was in a year when the five-year surplus of oil was drawing closer to even, leaving little room for luxuries like conflict in Iraq or unrest in Iran.

In 2017, World Bank President Jim Yong Kim said global economic momentum was "robust," but warned the interdependent world that normally binds peace to deeper levels of connectivity was "falling apart and countries and peoples are pulling away from each other."

In a weekend message on the New Year, U.N. Secretary-General António Guterres issued a red alert instead of an appeal, saying that many of the world's problems can be addressed only through unity.

"Narrow the gaps. Bridge the divides," he said. "Rebuild trust by bringing people together around common goals."

In November, analysts at Morgan Stanley said an oversupplied market for oil, a situation that pushed oil prices below $30 per barrel in early 2015, is a market that's more or less immune to risk like an interconnected world "falling apart." With markets tightening in the second year of OPEC's balancing act, geopolitical issues are a now an obvious factor.

"With economies around the globe recovering and supplies beginning to dwindle, oil markets may become increasingly vulnerable to political unrest," Morgan Stanley's report read.

With risk comes the need to play a good strategic hand. In his obligatory National Security Strategy, Trump, a president eager to remove anything that stands in the way of energy dominance, said the United States under his direction would use its newfound role as an energy exporter to build leverage overseas.

"As a growing supplier of energy resources, technologies, and services around the world, the United States will help our allies and partners become more resilient against those that use energy to coerce," the strategy reads.

That's a veiled shot across the Russian bow as the United States looks to send shale natural gas in a super-cooled liquid form deep into the Kremlin's sphere of influence.

Samantha Gross, a researcher at The Brookings Institution, said Trump's focus on energy dominance is a provocative one. The U.S. energy sector is a private one, she said, and the companies there are motivated by profit, not by politics.

Those sentiments were backed up by comments made to UPI by Johann Pleininger, a member of the executive board at Austrian energy company OMV, who said his company wasn't making deals along global fault lines.

OMV has a role in Russian plans to twin its Nord Stream natural gas pipeline through the Baltic Sea, though U.S. sanctions and European concerns about Russia's grip on the energy sector pose challenges to implementation. For OMV, however, Pleininger said business was business.

"We deal in business not geopolitics," he said.

But Healy Baumgardner, a global fossil fuel adviser at The 45 Group, former Trump campaign spokeswoman and the former press secretary for the Energy Department under President George W. Bush, told UPI the United States, with its new position as crude oil and natural gas exporter, finds itself with a unique strategic opportunity.

"With Saudi diversifying from oil; volatility in the oil markets including continued instability and lack of compliance within OPEC; and current geopolitical developments such as China, North Korea, Iran and Russia, President Trump is playing his cards correctly by harnessing this instability to re-approach bilaterally versus multilaterally to change the balance of power in domestic production and America's favor," she said. "Truly the art of the deal."

For OPEC members, especially the de facto leader Saudi Arabia, higher oil prices have their own political implications. This year will see the initial public offering for Saudi Aramco, the world's largest oil producer. Gross at Brookings said the offer, which could be valued as high as $2 trillion, is part of Riyadh's effort to transform the economy through a strategy dubbed Vision 2030 that could diversify its economic lifeline.

For the IPO to live up to its expectations though, the price of oil can't collapse, leaving Riyadh with a trump card of its own to play.

"With the Aramco IPO in 2018, the Saudis will continue to be assertive like activist investors in the oil market doing all they can to support prices to make the IPO a success," Hedgeye's McMonigle added. "I would not bet against them now."

Year-end analysis from commodity pricing group S&P Global Platts said about 1 million barrels per day were drained out of crude oil inventories last year, "virtually eliminating the entire surplus." A tighter market in 2018 leaves little margin for error and it may be the geopolitical factor as the one to watch this year.

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