There’s plenty to digest as we get the new week/month underway in trading today. The main story is that the US, alongside Israel, finally decided to launch military attacks against Iran. Reports are saying that the strikes were supposed to be carried out last week but were delayed due to operational and intelligence reasons.
Nonetheless, the escalation in military conflict is the key thing driving markets with Iran also fighting back. What is notable is that Iran is not only hitting back at US-based targets but is stirring up conflict in other places in the Middle East too.
Oil prices have surged higher on the weekend developments, with WTI crude opening with a gap up to above $75 before settling back down now to be around $71 as the volatility swings continue. It may be profit taking activity but also as there are plenty of issues to consider in all of this.
For one, movement along the Strait of Hormuz is now severely disrupted. So, that will essentially take away a large chunk of supply (even if just in terms of timing) with the Strait handling roughly 20% of the world’s oil supply.
The likes of Saudi Arabia and the UAE will have their own bypass pipelines but they surely won’t be enough to cover the lost volume. It is estimated that at best they can only make up for about 40% of supply disrupted from any “closure” of the Strait of Hormuz.
Again, the Strait isn’t exactly closed but nobody is willing to risk going through there in fears of being targeted by the Iranian military.
The other issue to consider is what this all means in the bigger picture. If the conflict is prolonged and lasts for a few weeks, that will definitely keep oil prices underpinned. However, is it only a matter of time before traders turn tail and focus more on the supply side of the equation again?
The backdrop coming into this year is that the oil market is going to be facing a supply glut. In fact, it was expected to be a heavy supply glut. One that could keep prices anchored at around $60 levels in all probability.
So with a change in leadership regime in Iran, there’s a chance that it could open the doors for the previously sanctioned supply to make its way back into the market. For some context, Iran is currently only doing backdoor deals with China to get out oil supply. But if legalised again, they could add more into a market that is already facing a supply glut.
Again, a lot will hinge on how things develop with regards to the Strait of Hormuz first and foremost. The bloc decided to increase oil output by more than anticipated, likely due to the US-Iran conflict.
And there’s also the fact that any short-term boost in oil prices would be the perfect excuse for US shale producers to go ballistic with the drills. Sure, they are just a tiny player when compared with what a closure of the Strait of Hormuz might mean for the oil market. However, any little thing to bring about a production surge is something to take note of.
As an aside, US shale producers have a backlog of wells that are already drilled but haven’t been fracked yet. So, any major surge in oil prices such as the one we’re seeing now is like a perfect storm for them to “flush” these wells to bring supply online. And they can certainly do so in a matter of weeks, not just months.
But again, US shale covers just roughly between 5% to 10% (at best 1 mil bpd) of any net loss resulting from the Strait of Hormuz closure (approximately 20 mil bpd).
Piecing all of that together, it looks like the oil market got a much needed shot in the arm and prices are now surging on the “initial shock”. But once markets have time to digest it all and the dust settles from the conflict, it seems that this will be a major opportunity for short positions to play. The only question is when and how long will the conflict and any major disruption last.
Just take note that we’ll be posting all the little tidbits and live happenings on our LiveBytes feed
