By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
The biggest black swan event in human history, other than the fateful but lucky asteroid hit that wiped out the dinosaurs in a mass extinction 65 million years ago, was Archduke Franz Ferdinand’s clueless driver, who took a wrong turn into a Sarajevo cul de sac on June 28 1914. A teenage Serbian terrorist shot the heir to the Austro-Hungarian empire at point blank range and triggered the chain reaction of events that led to a world war, ten million dead, the Bolshevik revolution in Russia, hyperinflation and the rise of Nazis in Germany and, finally, a second cataclysmic world war that cost the lives of 70 million human beings and the onset of the Cold War. None of the Great Powers in June 1914 wanted war yet the guns of August triggered industrial scale mass slaughter on the Western Front, the war to end all wars followed by Treaty of Versailles, the peace to end all peace.
The killing of General Qasem Soleimani in a Agency’s Predator drone attack in Baghdad, a Franz Ferdinand moment for the Middle East’s explosive (literally) geopolitical chessboard? As commander of the IRGC’s Al Quds Force, he was the Islamic Republic’s equivalent of CIA Director, NSC Advisor, Delta Force/Special Ops Command chief, Secretary of Defense, Ayatollah Ali Khamenei’s envoy to Putin, and Xi.
Unlike Osama Bin Laden, Abu Bakr al-Baghdadi or Abu Musab al-Zarqawi, he was a serving state official at the height of his power, a covert high priest of a new Persian Empire, when he was droned by Trump in Baghdad airport. Trump did not attempt “plausible deniability” but publicly bragged “we got him” in the podium of the Mar-a-Lago press room in West Palm Beach, Florida. This is an act of war, a significant step up the escalation ladder, a message of doom to the mullahs of Qom/Teheran. We got him.
Iran, undeterred by Soleimani’s killing, has promised “harsh revenge” a sentiment echoed by the Supreme Leader and including the ostensibly “moderate” Iranian President Rouhani and Foreign Minister Zarif.
Yet Iran cannot afford to fight a conventional war with the United States. Iran’s revenge will be vintage Suleimani/Al Quds doctrine and could include militia attacks, terrorist outrages on soft targets and embassies, seizures of oil tankers in the Gulf, attacks on US bases in Iraq, cyber-attacks against US financial institutions. In fact, if the killing of Suleimani is casus belli, so is Iran’s missile attack on Saudi Arabia’s oil hub in Abqaiq and seizure of a British oil tanker on the Straits of Hormuz.
Iran will also accelerate its ballistic missile and nuclear program in violation of the 2015 pact. The Middle East has once again entered the danger zone. This is the reason Brent crude is $70, West Texas is $64, gold is $1578 an ounce and Saudi credit default swaps have spiked. My Bloomberg screen flashes a war SOS.
The US had imposed economic war against Iran-maximum pressure sanctions. It has now established escalation dominance with the targeted assassination of a revered Iranian general, a modern Persian Rustom. In a mere week, a US contractors death in an airbase in Kirkuk has escalated into the most deadly international crisis in the Middle East since President George W Bush ordered the invasion of Baathist Iraq in 2003. Trump has chosen war, as has Khameini. Now both Washington and Tehran will learn the bitter lesson that it is easy to start a war but hard to end it.
This is a game changer event for the crude oil market and the geopolitics of the Middle East. The US said Soleimani’s killing made the world safer but the State Department immediately advised all Americans to leave Iraq at once – safer LOL?
After decades of covert/proxy conflict, the United States and Iran are now in a state of war and the world financial markets now reflect this grim new reality, as the 17% one session rise in Volatility Index suggests. The world oil market is thus white hot. Iran will harass oil tankers and commercial shipping in the Straits of Hormuz/Gulf of Oman, as the Pasdaran did last summer.
The Iraqi Prime Minister and Mehdi Army leader Muqtada al-Sadr have both called for an end to the American military presence in Iraq. Iraq, after all, is OPEC’s second largest oil exporter after Saudi Arabia and its oilfields/export terminals in Basra Province could well be targets of airstrikes if Baghdad allies with Tehran in its imminent war with Washington.
This means the world oil market will panic as it did in October 1973 (Yom Kippur war), February 1979 (Shah of Iran loses his Peacock Throne), August 1990 (Iraq invades Kuwait) and 2011 (NATO bombing and the overthrow of the Gaddafi regime, Libya). Strangely enough, call options buying on the energy ETF surged just before Trump ordered the drone hit on General Soleimeni’s motorcade. Coincidence or insider trading by Spook Capital, a hedge fund run out of Langley by Persia House team at Christians In Action? The SEC might just want to investigate the spike in call buying on XLE last week. As T. Boone Pickens loved to say in his Texan drawl “I was born at night. I just wasn’t born last night”.
Wall Street is dangerously underweight Big Oil, an entirely rational positioning since energy was the worst performing sector in 2019 and the entire decade. Now Wall Street is trapped. Lord Rothschild said “buy when the blood flows on the street” – or in this case (literally) the Iraqi desert. Even the September 2019 drone/missile attacks on Saudi Aramco’s Abquiq/Khurais oil processing complex triggered a $8 a barrel spike in Brent that gave back all its gains in a month after Prince Abdulaziz assured the market that the kingdom would bring Saudi output online in a month.
True, the Permian Basin in West Texas has shale oil reservoirs and has made the US energy independent but vast economies like China, Germany, India, Japan, and South Korea still live and die on access to hydrocarbons. Not even a hundred Elon Musks/Teslas or armies of robots will change this fundamental equation of the Hydrocarbon Age.
All the macro indicators I track point to higher crude oil prices even if Trump had not ordered the fateful drone strike in Baghdad. The Powell Fed has made it clear that its mantra will be easy money even if inflation rise above its 2% target. The Chinese just injected $115 billion in their banking system to revive economic growth – and the Middle Kingdom is the largest consumer of petroleum in the Milky Way. OPEC, led by Russia and Saudi Arabia, increased its output cuts from 1.2 MBD to 1.7 MBD in Vienna. The US dollar has begun to sag. North American inventories have begun to tighten. Turkey intends to militarily intervene in Libya, as it has in Syria (the Kurdish Rojava) and northern Iraq (the Qandil Mountains). And now two founder members of OPEC (Iraq and Iran) could face armed conflict with the United States while a third (Venezuela) dies under sanctions.
While the official data argues that Trump’s “maximum pressure” sanctions have slashed Iran’s exports from 2 MBD in mid-2017 to only 250,000 now, the fact is that China is buying smuggled Iranian oil via Russia and Turkey. The US will pressure Beijing to stop this leakage now as it must bankrupt the Ayatullah regime before war escalates. So the Chinese will bid for crude tanker cargoes in the Rotterdam, London and Singapore spot markets for blackgold. If Basra Light exports to China are disrupted or Kharg Island is bombed by US warplanes from Al Udeid Air Force Base, the world will face an immediate, full blown oil panic. Then we will face a new economic reality at Brent $100 – an oil shock and global recession, a replay of 1974, 1979, 1991 and 2008. If 2019 was the year of “don’t worry, be happy, make money”, the year of the Jay Powell bull market, 2020 could be the year of the General (ghost) Soleimani bear market.
For now, oil and gas shares will rock. Shale drillers like Hess and Apache are up 25%, Pioneer is my favourite takeover candidate, as Anadarko Petroleum once was, before the bidding war from Oxy and Chevron. Big Oil beauties? BP, Total, Chevron, even John D Rockefeller’s stodgy old Jersey Standard – now called Exxon Mobil.
I desperately hope I am wrong – but what if I am right? It is August 2020. Crude oil has surged to $128 a barrel – its exact level the day Colonel Gaddafi, a marginal oil exporter relative to Iraq, was lynched as he emerged from a Libyan drain pipe in October 2011. The US economy has gone into recession – July payrolls were a dismal 700,000 down. The US and its allies are engaged in a full scale war across multiple fronts (including cyber and space) with Iran and its proxy militias in Iraq, Syria, Lebanon, Afpak and Yemen. Oil tankers in the Gulf face constant suicide bomb threats from Pasdaran zodiac boats (echoes of the USS Cole). Russia, China and Turkey keep Iran’s militias and armies supplied with high tech hardware. World War III? No – that would mean instant sunshine but ain’t no sunshine when she’s gone. The UN Security Council runs amok, as usual, like an impotent headless chicken. There comes November 2020 and Elizabeth Warren wins the White House in a landslide while global equities slump by 50% and real estate market crash worldwide. Cassandra fantasy? No, a credible macro scenario for the crash of 2020.