Tensions are mounting in the Middle East. Tanker attacks in the Persian Gulf - especially around the Strait of Hormuz – are of particular significance to the oil markets. Roughly 20% of the world's oil supply passes through the Strait every day, including exports from Saudi Arabia. Yet despite the latest attacks, oil prices have moved only modestly higher. In the past, conflicts involving Middle East producers caused a far more significant move in oil prices (see Fig. 1).
Fig. 1 Brent and WTI oil prices in USD/bbl
Sources: Thomson Reuters, UBS
Why the indifference in the oil market?
There is likely more than one reason for the muted reaction in oil prices. Among them:
* Demand concerns continue to lurk, reflecting ongoing caution over a slowing global economy, exacerbated by uncertainty on whether a trade agreement between the US and China will happen soon.
* Meanwhile, on the supply side, disruptions thus far have been limited. The world seems well-supplied with oil at the moment, although this sentiment is buoyed in part by ample spare capacity in Saudi Arabia.
* US production continues to rise and the short-cycle drilling in the US onshore suggests that more supply could be brought on quickly. US oil inventories have been rising, suggesting a current surplus.
* There may also be some element of doubt that Iran could block the Strait. While it may temporarily slow down the flows, the situation is unlikely to persist for a lengthy time.
Clearly to us, the tension is real and represents a threat to oil supply from the Middle East. The spare capacity the Saudis hold would likely not be available to the rest of the world if flows via the Strait are impacted. Alternatives to bypass that chokepoint are limited. Also, while the world would look to the US to fill a large portion of a supply shortfall in the Middle East, the reality is that the US could not ramp up production to plug a significant supply gap on a timely basis. But even so, there may be some validity to the focus on US production to help stabilize oil prices globally. New supplies would require a 6-9 month lead time, but Strategic Petroleum Reserves in industrialized countries (OECD) would likely be tapped to satisfy more immediate needs. The US, the world's largest oil consumer and holding the largest strategic oil reserves, could remain reasonably supplied domestically. So prices for the US benchmark crude – West Texas Intermediate - have remained in check.
Brent is the global crude oil benchmark, and is the more appropriate proxy for global oil market fundamentals. But the relative price between Brent and West Texas Intermediate, where Brent currently trades at a USD 6.50/bbl premium to West Texas Intermediate, matters. If the spread grows wider, demand for cheaper West Texas Intermediate will rise and Brent demand will fall. The same would go for their respective prices. Granted, the US has been exporting some 3 million b/d of crude oil, and this figure would likely rise if production growth were accelerated. But all things given, it is possible that West Texas Intermediate prices have thus far held Brent prices in line.
Shout out to North America's energy independence
Further escalation of tensions would likely increase oil prices everywhere. But the US is no longer reliant upon large quantities of oil imported from OPEC, and increased US exports could cap the upside in global oil prices. While the tensions between the US and Iran are not about oil, oil has been used in the past by Middle Eastern nations as a weapon to inflict economic pain on the US in contentious times. With that weapon now less effective, perhaps this time the conflict is less likely to devolve into a costly and unfocused military engagement over oil.
Author:
Nicole Decker, Energy Analyst Americas, UBS Financial Services Inc. (UBS FS) Giovanni Staunovo, Analyst, UBS Switzerland AG
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