The oil market is poised to contain the price fallout from the assassination of a key Iranian commander, but perhaps only for the immediate future....
The Big Picture
Crude oil rose nearly 4 percent on news of the U.S. strike that killed senior Iranian military official Qassem Soleimani in Iraq. In the short term, however, it will be difficult for the market to price in much more risk regarding possible Iranian retaliation without suffering actual losses in volume. In the next few weeks, Iran has reason to avoid strikes against tankers or its neighbors' oil infrastructure, but that could change in the longer term.
The killing of Maj. Gen. Qassem Soleimani, head of the Quds Force unit of the Islamic Revolutionary Guards Corps (IRGC), is reverberating around the world, not least of all in oil markets. The price of crude oil has surged nearly 4 percent since the United States killed the senior Iranian military leader in Baghdad early on Jan. 3 — although the rise is only about a third of the rise that occurred in the first trading session after Iran attacked Saudi oil facilities at Abqaiq and Khurais in September.
Though there is no doubt that Iran will retaliate forcefully against U.S. interests and personnel in the Middle East, the oil market is loath to price in a large risk premium in the absence of any action that actually decreases global oil volumes. As it is, the market wants prices to stay level to dramatically slow U.S. shale growth and to prevent cash-strapped producers from jumping at the opportunity to ramp up production to make extra money if prices do rise. Ultimately, with the market jittery about when and how Tehran will exact revenge, prices are likely to remain volatile in the near term — even though Iran has reason to avoid direct attacks on global oil infrastructure for now. In the longer term, however, any Iranian retaliation that takes oil off the market is bound to cause a jump in prices.
What It Means
U.S. personnel and facilities in Iraq are the most likely target for retaliation by Iran and its proxy forces. Indeed, foreign oil companies that were working to expand Iraq's production capacity at several major oil fields, mostly near Basra in southern Iraq, have already begun to evacuate their American and other foreign staff. Iran, however, will want to maintain the support of Iraq's political class — which will find itself further alienated from the United States over Soleimani's killing and other recent events — suggesting that Tehran will have no incentive to take action that would harm Iraq's oil exports or revenues. Iraq, moreover, has enough skilled workers to operate oil infrastructure without foreign help, meaning the impact of the loss of foreign staff will lower ultimate capacity growth but not result in a steep drop-off in production levels.
What's more, while Tehran could well target U.S. naval vessels, it is unlikely to launch a campaign against oil or liquefied natural gas tanker traffic in the Persian Gulf in the near term. Instead, the country will set a high threshold for attacks that impact tanker traffic in busy waterways like the Strait of Hormuz or the Bab el-Mandeb, as the country wishes to maintain diplomatic support from China and Russia. Indeed, Supreme Leader Ayatollah Ali Khamenei avoided mention of the Strait of Hormuz when vowing retribution for Soleimani's death, as Iran seeks to maintain the modest volume of oil exports it currently conducts, mostly to China.
Iran is unlikely to conduct a renewed assault on Saudi oil facilities like Abqaiq in the near term — although all bets could be off if there is an escalation between Washington and Tehran in the coming weeks.
Likewise, given the recent lull in tensions with Saudi Arabia and the United Arab Emirates, Iran is unlikely to conduct a renewed assault on facilities like Abqaiq in the near term — although all bets could be off if there is an escalation between Washington and Tehran in the coming weeks. The Abqaiq and Khurais attacks briefly raised the cost of oil, although prices quickly dropped when it became apparent that Saudi Arabia could quickly reroute production and restore output thanks to redundancy. Still, there is plenty of reason to believe that Iran is capable of mounting an attack using more cruise missiles, which could hit more critical components at facilities like Abqaiq and Khurais. In fact, the United States recently deployed 3,000 military personnel to Saudi Arabia in part to assist with air defenses, including in the vicinity of these facilities.
The Upshot
All of this suggests that oil prices could stall — or even slide back down — in the coming days if there is a shift in conditions, global oil inventories begin to rise once more and Iran avoids taking any major action that directly disrupts the market. That's because it would be difficult for Brent crude oil to make a sustained, immediate run higher in the absence of actual volume losses given that major oil producers wish to keep prices as steady as possible. But should Iran subsequently choose to respond to Soleimani's assassination with retaliation that directly takes oil off the market, a rise in prices would become inevitable.
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