Oil Is Higher As Sanctions Take Effect: Will That Last?

A while back, President Trump broke from the Iran nuclear deal and announced renewed sanctions on the country. There was a grace period to allow others to disentangle themselves, then at midnight last night those sanctions began. Crude oil reacted in what seems, at first glance, to be a logical manner, but one which, when you stop and think, actually makes little sense.

The international oil benchmark, Brent, saw futures jump over one and a half percent, while the less directly affected U.S. benchmark, WTI, rose around one and a quarter percent. While that seems sensible, the fact is that these are futures contracts, and we have known this day was coming for a long time.

In theory, any effects of the sanctions should have been priced in a while ago.

To a large extent they were. WTI has had a good year, rising from around $45 per barrel a year ago to a high of over $75 last month. Prices have since corrected back a bit, but the average price since Trump announced his intentions on May 8 has been around $70. That is a long way from the days of oil over $100 a barrel, but it is significantly higher than long-term averages, and therefore seems to have discounted the loss of Iran’s production.

Yet still, when the clock struck midnight, oil popped. I guess there were a few people who thought that either Trump or Iranian President Rouhani would back down and avert the crisis. If so, those people have not been paying attention to the style or political situation of either man. Both are embattled at home and will relish the opportunity to vilify an enemy overseas, as both a distraction from the allegations of corruption and as a rallying cry to their supporters. A conflict was almost inevitable and once on the road to one no course changes could logically be anticipated.

Anyway, whatever the reason for last night’s jump in crude, it is unlikely to be maintained given other news in the oil market.

On Friday of last week, we learned that OPEC output was nearing record highs. The November 2016 agreement between OPEC and some other major producers to limit crude output is still in place, but it could be argued that said agreement is effectively no longer in force. The last time the parties met, they agreed to increase output. Those increases were not that large, and really only made up for shortfalls from Venezuela and Angola alongside the anticipated loss of Iranian oil to the market. However, what makes them significant is not their size but their distribution.

OPEC has always been a miracle of sorts. It is a group made up of disparate countries around the world, all with different agendas and goals. In the case of those in the Middle East, the differences go even further, with cooperation between countries that are otherwise enemies often with centuries of bad blood and disputes. Greed is truly a powerful thing, but in the current circumstances, we are seeing that those long-term tribal conflicts never completely go away.

The output increases were approved by the group as a whole, but they are not being applied evenly across the board. Almost all the increased production is coming from Saudi Arabia and its allies such as Kuwait and the U.A.E. Others in the region are not sharing in the bounty, and in many cases are even seeing a drop in output.

We are, it seems, returning to an OPEC divided, and when every country is for itself, price declines will follow.

That situation is likely to be exaggerated by events outside of the cartel, and here in North America in particular. If prices do turn and head towards $60, there will be a rush among domestic producers to get oil out of the ground and/or sold while the going is still good. That will add to any declines.

The pop in crude prices last night may seem logical as sanctions are becoming reality, but, given the forward discounting nature of markets and the big-picture in terms of supply, it is unlikely to last. Of course, if the current conflicts heat up into actual wars all bets are off, but in the absence of that nightmare scenario oil looks set to fall in the coming months.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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