Increasingly tough talk by both Washington and Tehran, and the deployment of U.S. troops to the Gulf, has coincided with several flashpoints in the past week. The identity of perpetrators of a May 12 attack on tankers off Fujairah in the United Arab Emirates remains a mystery. Meanwhile, Saudi Arabia has blamed Iran-backed Houthi rebels in Yemen for separate assaults on its oil infrastructure. Yet despite a 2% jump since May 10, a barrel of the black stuff is still cheaper than in late April.
One explanation for the relatively sanguine reaction is that traders don’t believe the United States would risk a serious confrontation. It’s normally cheaper to buy a barrel of Brent crude next month than seven months from now. Right now, however, the opposite is true. Indeed, the premium on short-term oil recently hit its highest level since 2014. That’s a reliable sign of short-term supply shortages. So is the 700 million barrel net long position that money managers have taken in the commodity, according to data from the U.S. Commodity Futures Trading Commission and Intercontinental Exchange.
Fundamental factors support this position. Pipeline contamination that has taken Russian oil off the market has restricted supply in 2019, as have unintentional disruptions in Venezuela and intentional ones in Iran. New sanctions imposed by Trump have cut Tehran’s exports from 2.5 million barrels per day to near 1 million. The U.S. wants to reduce them to zero.
Yet a conflict could affect traffic through the Strait of Hormuz. Oil equal to a fifth of global consumption passes through the narrow passage between Iran and Oman. Any disruption would lead to a spike in prices.
The U.S. president may feel he has scope to act tough. One reason for tight supply is that Saudi Arabia is currently pumping over 2 million barrels of oil per day less than its capacity of 12 million barrels per day, the result of cuts implemented by the Organization of the Petroleum Exporting Countries and allies like Russia to get rid of last year’s supply glut.
Trump has even more leverage over Riyadh than usual to press for the taps to be opened if necessary. After all, the president publicly exonerated Saudi Crown Prince Mohammed bin Salman from blame for the murder of journalist Jamal Khashoggi by Saudi agents last year. Most Gulf states have minimal trade links with Iran, according to Capital Economics. Trade war tensions that weigh on global economic activity will also help keep a lid on oil prices, as will America’s own rapidly growing crude output.
Yet Trump’s hedge against an Iran-related price spike is far from perfect. Saudi might hesitate to annoy fellow OPEC members by opening its pumps. Practical constraints also mean Riyadh can only ramp up production by 1 million barrels per day in the near term – enough to offset a total halt to Iranian exports, but not to stop prices shooting up if war breaks out. And while the International Energy Agency reckons U.S. shale oil could provide three-quarters of the growth in global supply to 2024, this is so-called light crude. Many U.S. refiners are set up to process heavier grades that largely come from the Gulf and Venezuela. A war could therefore still push up the price of diesel which powers trucks and heavy industrial machinery.
Trump may conclude that forcing regime change in Iran is more important. But if the president is still focused on keeping oil prices down, he has little scope for more than sabre-rattling.