Complex Made Simple

The game of nations and the global crude oil market

The world narrowly escaped the start of another catastrophic war in the Middle East last week and the angels of mass megadeath spared our region after the US President gave the order to abort air strikes on Iran. President Trump concluded 150 human lives were too high a price to pay for a downed unmanned spy drone. “He who saves one life, saves the world entire” (Schindler's List). Whoever saves a soul, it is as if he has saved mankind entirely” (Holy Quran 6:32). Then there are the Ten Commandments – “though shall not kill”. Thank you, Mr. President, you were “cocked and loaded” to strike your target but you did not kill – at least for now.

The OPEC plus Russia meetings will take place in early July at a critical moment for the Middle East. Brent futures trade at $64 as I write, well below their $74 high in 2019 but boosted by the US-Iran tensions and the Saudi-Russian output pact’s extension. The oil market will be mesmerized by Osaka, events in the Gulf, US petroleum stockpiles and gasoline prices. The game of nations – geopolitics – will move the price of oil, now hostage to decisions taken in Washington and Beijing, Tehran and Moscow, Riyadh, Baghdad, Kuwait and Abu Dhabi. So it is mission critical to dissect the game of nations and its impact on global crude oil and LNG prices in June 2019.

Iran’s grand strategy since the 1980’s has been to use proxies to achieve its strategic goals abroad – in Iraq, Lebanon, Syria, Yemen, Gaza, Bahrain – at virtual zero cost to its theocratic elite or sovereign territory. The mining of oil tankers in the Gulf of Oman, a Katyusha missile hit near Exxon Mobil’s concession in the Zubair oil field in Iraq or Houthi rebel ballistic missile strikes against the Saudi cities of Abha and Najran perfectly fit Tehran’s modus operandi. Iran has often threatened to close the Straits of Hormuz after the Trump White House imposed draconian financial sanctions on its banks, oil companies and state institutions. Yet it cannot credibly challenge the sheer firepower of a US naval fleet in the Gulf, led by the aircraft carrier USS Abraham Lincoln, with its squadrons of F-18 Hornets and Tomahawk missiles ready to destroy its most high value military targets deep inside the Islamic Republic.

The revolutionary regime in Tehran’s past behavioral patterns of asymmetric warfare suggest the risk of a USS Cole style assault on an American warship in the Gulf is all too real. This was the reason Brent crude surged to $65 a barrel as the news wires reported that Iran shot down a US spy drone. The financial markets fear an escalation in asymmetric attacks on oil facilities will inevitably lead to full scale war between the US and Iran. This is the reason volatility has spiked in both West Texas and Brent light sweet crude contracts in the London and New York oil futures markets. The oil market equates any threat to a prominent energy chokepoint (e.g. Straits of Hormuz, Suez Canal, Bab-el-Mandeb) as a threat of imminent war in the Gulf.

Geopolitical risks have been a recurrent theme in the evolution of the global crude oil market. The October 1973 war in the Sinai and the Golan Heights, coupled with an Arab oil embargo against the US and Holland as well as panic Japanese buying in the Rotterdam spot market, led to a fourfold increase in oil prices and gas lines/recession in the West. Oil prices doubled between June 1978 and February 1979 as street protests against the Shah of Iran’s Peacock Throne escalated into a bull blown revolution led by Ayatullah Khoemini, hitherto an exiled Shiite cleric in Najaf, Iraq and a Parisian suburb. There were swift oil price spikes when Baathist Iraq’s armies invaded Kuwait in August 1990 and the US/Britain invaded Iraq in March 2003 to overthrow the regime of Saddam Hussein.

Oil prices surged to $128 in October 2011 when a NATO bombing campaign resulted in the killing of Libyan dictator Colonel Muammar Gaddafi. Oil price spiked to $115 Brent in June 2014 when two Iraqi Army divisions were unable to prevent the Daesh terrorists from seizing Mosul, the second largest city in Iraq. Events in Russia, Venezuela, Nigeria, Libya, Algeria, Sudan, Mexico and Indonesia have impacted oil prices in the short run but the biggest moves happen only when there is a tangible threat of disruption to the oil infrastructure – oilfields, LNG plants, storage depots, pipelines or tanker fleets of the Gulf, the epicenter of global energy security. This is the reason limpet mine attacks on oil tankers in the Gulf of Oman, sabotage against pipelines in Bahrain or cyber-assaults against Aramco oil processing complexes in Saudi Arabia immediately add a geopolitical risk premium to oil prices.

It is premature to expect a diplomatic solution to the four-decade old US-Iran imbroglio. The best hope is that the world averts a protracted, bloody war between the armies of the “Great Satan” and the “Axis of Evil” for control of the most important energy jokepoint and tanker shipping sea lanes in the Middle East.