In oil markets, geopolitical turmoil is back with a vengeance

When oil prices are low, it’s common to hear claims of the demise and growing irrelevance of energy geopolitics. The years after 2014, when oil prices cratered to lows in the $20s, illustrated this shifting narrative. 

Oil’s rapid price collapse between 2014 through 2016 led many to announce a reprieve in the geopolitics of energy.  Civil wars in Syria and Libya and declining production in Venezuela and Nigeria weren’t enough to move the market up. 

{mosads}Excess supply, compliments of U.S. shale oil production, kept markets satisfied; the security premium on oil was all but erased from the price. Today is different and will be for the months ahead. A deluge of bullish headlines is keeping the market on its heels and volatile. 

Brent is at its highest level since 2014 moving briefly into the low $80s on Friday. A significant deterioration in one or more regions of the world could result in a price spike into the $90s. 

Increasing strife across the Middle East is only part of the story. Commercial oil stocks are also at their lowest in three years, and the supply glut of the last four years has all but evaporated, making supply-demand fundamentals more vulnerable to geopolitical risk. 

Geopolitics are back with a vengeance in 2018. Recent upticks in price reflect the return of the security premium on oil. The weeks ahead will test just how sensitive the market is to today’s geopolitical realities. 

We’re seeing a spring of discontent on many fronts. Last week determined the status of the Iran deal for the U.S. President Trump withdrew from what he and his administration viewed as a highly flawed and bad deal for the United States. 

Time will tell how European partners respond and whether their commitment to remaining in the deal holds over time. Since 2015, Iran has raised production to 2.5 million barrels a day. Analysts are pondering what the impact of recent developments will be on Iranian barrels. 

Numbers ranging from 700,000 to 300,000 in lost barrels from Iran are now being factored into market pricing.   Increased production from the U.S. and promises from Saudi Arabia to make up for any shortfalls out of Iran may not be enough to keep the global market for oil adequately supplied. Uncertainty prevails.

On Sunday, Venezuelans go to the polls in what the U.S. and many European countries are calling a sham election that they refuse to recognize. Whatever the results, the situation in Venezuela will get worse before it gets better. 

A big question is whether the U.S. will ban oil imports from Venezuela? The U.S. buys approximately 500,000 barrels a day, so sanctions against its oil will dramatically hit the country’s only viable revenue lifeline. 

Even without the imposition of a ban, Venezuela’s gross mismanagement of the oil sector has created a debilitated sector unable to maintain an already inefficient and underfunded oil industry. Ninety-five percent of the country’s foreign currency earnings comes through the sale of oil, and supply is down by over 600,000 barrels per day for this year alone. 

Venezuela has gone from producing 3.5 million barrels per day (mbd) to just above 1.5 mbd and bets on a collapse to 1.2 mbd. Council on Foreign Relations Senior Fellow Amy Myers Jaffe expects “oil production to continue to crater” while the government is unable to fund even basic and essential services, let alone keep the machinery of the oil sector functioning. 

Mexico’s election represents another risk for oil markets. Andres Manuel Lopez Obrador, currently in the lead to replace Enrique Pena for president, has threatened to roll back the historic 2013 energy reforms, which opened the country’s nationalized oil sector to domestic and foreign privatization. 

The energy reform needed a constitutional amendment requiring at least two-thirds of the votes of legislators and half the support of state congresses, so reversing them can’t happen overnight, but the threat of a reversal would definitely dampen investor appetite for taking on new investments in the country. Rolling back reforms and revisiting already signed contracts would have seismic shifts in the market beyond Mexico.  

Next month, OPEC meets in Vienna, and the question everyone wants answered is the future status of cooperation between Saudi Arabia and Russia. Will production constraints hold or will the temptation of higher prices weaken production discipline? 

The cuts totaling 1.8 million barrels a day, by all accounts, have helped to prop the oil price up, and most analysts believe the limits on production will stay in place at least through the end of the year since both the Russians and the Saudis are enjoying a return to higher prices. 

Russia and Saudi Arabia don’t have a history of being great bedfellows, but over the last two years, the relationship has warmed to the point that even differences about Iran and Syria are not getting in the way of extending their commitments to restricting production to further bolster prices.   

Will spring’s volatility lead to calm in the summer? It’s unlikely given what’s happening around the world. Expect risks to be many and upward price volatility to take us into the fall. 

Carolyn Kissane is the academic director of the graduate program in global affairs at the Center for Global Affairs at the NYU School of Professional Studies and is also a clinical professor, teaching graduate-level courses examining the geopolitics of energy, comparative energy politics, energy, environment and resource security. She is a non-resident fellow at the Payne Institute for Earth Resources.