This post is opinion only. See full disclaimer below
I have said repeatedly that with the price of oil, unless things significantly change from the present macro-political situation, a slow train is coming. Metaphorically, what that means is that at some point in the not too distant future the markets may have to reprice from a financialized asset kept at an artificially low price to a real price. Has this already been manifested in part in crack spreads on gas and diesel where the differentials have exploded higher–sure but we are talking here about the actual oil price itself. Now let me preface the following discussion with the obvious point that the current situation is so volatile that it could all change rapidly. And let me also say, yet again,that unless you are sitting in a situation room in some country it is impossible to fully know the picture. That said, however, the following points are crucial for a Weberian style analysis at this juncture.
- The assumption of a fast resolution in the Iran War confronts the reality hardly discussed that Iran sustained itself in a severe war with Iraq for years that resulted in some experts believe upwards of 300000-500,000 killed Iranians. Despite extensive aerial bombings and the “War of the Cities” missile strikes, and use of chemical weapons by Iraq the war lasted nearly 8 years and was one of the longest conventional wars of the 20th century. .The idea that Iran will at some point simply give up and make a deal is questionable. It might take a ground invasion and that path is highly unclear.
- Related to this first point, the strategy of aerial bombardment and severe economic sanctions is entirely unproven. Could it succeed? Perhaps, but there are very few historical examples of such an approach working. In World War II, even the severe bombings and in some cases fire bombings with massive casualties did not lead to surrender. It was not till the US used nuclear weapons against Japan that they surrendered and no serious person thinks that is an acceptable path against Iran and it will not happen unless Iran were to itself attack with such a weapon. Unlike in World War 2 the power of the US in the international economic system it set up is much greater though so perhaps economic sanctions can in this case prove more effective, who knows.
- The real-politique point of the Thucydian inevitable victory of a large powerful country over a smaller enemy is present conceptually, but the power of asymmetric warfare here may radically change the equation, and if that point was true in a simple sense how did the French and the US lose Vietnam?
- How long will it take even if the Strait of Hormuz opens tomorrow to replace the perhaps 1-2 billion barrels of oil, according to some experts, drawn down from strategic reserves or to fix the extensive damage done to oil infrastructure in the Middle East?
- If AI is a bubble, and I have in earlier posts suggested why that could possibly be the case, but also how AI’s role in national defense could change that calculus—but if it is, what would the effect be on this technology of a severe spike in oil prices if it occurs or even a prolonged major change in the floor price for oil?
- How much does the continued risk globally of strikes on oil resources using drone technology, whether in conflict between states or by rogue actors, change the ongoing risk premium in oil. The extensive use of these weapons in the Ukraine and Iran wars introduces risk to oil markets largely absent in earlier periods.
- How much does the war between the Houthis and Yemen put at risk Saudi infrastructure? Can the Houthi’s be defeated or forced to stand down? Obviously the recent closing of the Petroline by Iranian proxies in Iraq suggests that there is continuing risk in this regard. That risk appears to have been quickly mitigated and increased safeguards are probably now in place but the risk continues. How would new US intervention in that theater of war or the more likely intervention of Turkey and Pakistan change the outcome? The result of the earlier intervention by the US is unclear in this regard. On the one hand the Houthis did stop attacking US assets, but on the other hand they were not really defeated either.
- If the US escalates either before or after the upcoming election will that involve infrastructure attacks as threatened? If so, the Iranians have indicated they will attack oil throughout the region. What would the result of that be? Will Iran make a deal before that and would they ever accept new controls over either the Strait or their nuclear program or do they see both as central to their power in the region going forward? Also, will elites in Iran tied to the nuclear program accept a major change in the significance of that program? Will the US decrease their demands to get a deal?
- If there is an oil shortage and an oil spike, how will Asia and the global economy be effected? Are Asian markets vulnerable in such a scenario and if so what would the effects be on the broader global economy? This is a huge issue.
- How much do the US midterm elections matter for all of this. What are the likely scenarios if the Republicans or Democrats win both houses or if the Republicans retain the senate but not the house?
- Will Israel rejoin the Iran War? And if so, how does it change the situation, and how will a win by Netanyahu or the opposition in the upcoming Israeli election change these scenarios?
- In broader macro terms, will oil as a diminishing asset face upward pressure given current replacement rates, or if peace is reached will there be a substantial oversupply again as high production numbers in the face of the supply shortage meets new oil fully coming back online?
- How much do the longer routes required to move oil in some cases around the Cape of Good Hope, which I have written about elsewhere, a shortage in tankers in part because of longer routes, super high day tanker rates that have spiked much higher and in some cases now require much more days to roundtrip, decreases in throughput rates given the need for escorts or ship to ship transfers, fundamentally change oil supply-demand curves?
- Has Trump given up the limitations of the deal framework or is his perspective still too limited for the current conflict? Will the approach to the war ultimately prove to be a new strategic blueprint or a failure to do the required preplanning of the earlier Bush Administrations or the necessary longer term diplomatic process?
I could go on, but hopefully these few points make clear just how uncertain the current moment is. Any 30-something trader, who thinks this situation is simple or that it doesn’t matter for the broader market or any broker pushing AI stocks to clients who thinks that all of this is totally insignificant, may be very wrong indeed.
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