Once, when my wife and I were first dating, we went to Bass Pro Shops. She was basically a city girl at the time, and when the gun counter guy asked her if she had ever held a gun, she said no. He hands it to her, and to my shock, she points it right at his head. That’s about how oil traders feel right now.
The oil markets are in the crosshairs of the potential escalation between the US and Iran. Most of the concern is about transporting oil in the volatile Middle East region, especially if there were to be a blockade of the Strait of Hormuz. This 21-mile-wide strait in the Persian Gulf is where 20-30% of the world’s oil supply is shipped, and it lies on Iran’s shores.
The fact that so much of the world’s oil is shipped through that area is raising concern in commodity markets. Analysts are noting a rise in insurance premiums for oil tankers operating in the Persian Gulf, which has also contributed to oil prices rising by more than 13% at the beginning of the year. However, it is not just the risk of war or regime change that is driving up oil prices in recent weeks.
The Energy Information Administration (EIA), an agency of the US Department of Energy, shows US oil inventory levels lower than markets expected at the beginning of the year. The fact that refineries are running at near-maximum capacity to produce gasoline and diesel, while oil inventories are lower than normal, is also driving up oil prices.
The winter weather isn’t helping either. The January polar vortex that hit much of the US, especially the Northeast, increased heating oil demand. It even led to the rare use of oil-fired power generation in parts of New England that are trying hard to remove fossil fuels from their energy production. This has also resulted in a stronger drawdown of crude oil, driving up oil prices.
Despite these current factors driving up oil prices, prices could be held in check. If the Iran tension fades either through an agreement or a quick strike without other nations getting involved, the added regional risk and expense could fade quickly, returning to a supply-and-demand pricing model. We should also never forget Saudi Arabia and the rest of OPEC, which can restrict or flood markets with oil, dramatically affecting global oil demand and pricing.
The worst-case scenario would be if the Iran situation were a drawn-out war with multiple Middle Eastern nations involved. I do not see this happening, but the US has gathered more air power in that region since the 2003 Iraq invasion. If a larger war broke out, this could lead to a dramatic rise in oil prices by restricting tankers leaving Iraq. If this unlikely situation were to unfold, I would adjust my portfolios to add more defense stocks and some US government-backed securities in the event of a larger war in the Middle East.
No one knows for sure what President Trump or the crazy Iranian leadership is thinking, but it seems Trump will do something. Most analysts believe that if Trump can’t get an agreement, he will try a quick operation similar to the one in Venezuela. Time will tell, and investors need to be paying attention.
Thirty years later, my former city girl has learned some country ways. She now knows gun safety and could protect herself if she were ever in danger. Oil, on the other hand, can’t protect itself and has to ride the waves of politics.
Have a blessed week!
Richard Baker
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Fervent Wealth Management is a financial management and services entity in Springfield, Missouri.