Oil Prices

Oil Prices Continue to Ride the Threat of a Further Escalation of US-Iran Conflict

Early Friday morning, an American drone strike killed Qassem Soleimani, the commander of the Quds Force. The Quds Force operates as a foreign military apparatus under the ambit of the Islamic Revolution Guard Corps (IRGC). Just two hours after the news broke out, crude oil WTI futures jumped 2.80% to $62.88. At the time of writing, the futures were up 1.28% to $63.86 for the day.

Source: Investing.com

Why is Soleimani’s assassination significant to oil prices?

Iran is one of the five founding members of the Organization of the Petroleum Exporting Countries (OPEC). OPEC is a powerful organ whose aim is to present a unified policy as far as petroleum production and export is concerned among the members. Besides the OPEC membership, Iran has the second-largest oil deposits in the Middle East after Saudi Arabia. As of 2018, Iran had 155.6 billion barrels of oil reserves. In November 2019, reports emerged, revealing the founding of an additional 53 billion barrels of crude oil in Iran’s Khuzestan province.

Besides, Iran has critical control of the Strait of Hormuz. This 39 km strip of water is the only connection there is between the Gulf of Oman and the Arabian Gulf. Notably, all the gas that Iran and Qatar produce passes through this area. In addition, more than one-sixth of oil produced globally is transited via the Strait of Hormuz. International shipping companies use this strait to feed the rest of the world with billions of barrels of crude and refined oil every year.

From the foregoing, Iran is a powerful player in the global oil industry. Any disturbances in the Strait of Hormuz imply supply shortages and, consequently, price surges. This is exactly what the market feared after the U.S. confirmed Soleimani’s assassination. Notably, Soleimani is a popular figure in Iran and its allies. Particularly, the Quds Force, which Soleimani commanded, plays an important role in the geopolitics of the Middle East.

What next for the market?

Since the Friday incident, threats have been flying from Iranian authorities and several militias in Iraq and Lebanon towards the U.S. and Israel. Notably, the Islamic Revolution Guard Corps (IRGC) on Saturday threatened to punish “some 35 U.S. targets in the region as well as Tel Aviv” within their reach. In response, U.S. President Donald Trump tweeted that any retaliatory attack by Iran would attract a massive obliteration of 52 sites within the country. Two days before the tweet, the U.S. sent close to 3,000 troops to Kuwait. Additionally, the U.S. has asked its citizens to leave Iraq.

To the market, the actions by both Iran and the U.S. point to the possibility of an all-out war. If indeed war breaks out, there is a possibility of crude oil inventories suffering a huge negative impact. The war will stop further production of oil, and the Strait of Hormuz will be a hostile region. As such, there will be no supply of oil to refineries across the globe that rely on supply of crude oil from the Middle East.

The future direction of the market, therefore, depends on the direction that the Iran/U.S. conflict will take. Fortunately, various leaders, including leaders of Germany, the U.K., and France, are calling for the two sides to refrain from escalating the conflict further. If the tensions do cool down, the threat of oil suffering major supply shocks will subside. The resulting calm should encourage the market to lower its expectation of higher oil prices in future. Consequently, crude oil futures will begin to fall going forward. However, all this depends on the direction the Iran/U.S. conflict takes.

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