The Three Events That Just Sent Oil Sinking… and Why There’s No Need to Panic

Yesterday, three geopolitical crises converged, sending the price of oil sinking.

West Texas Intermediate (WTI), the benchmark for crude set in New York was down 8%. Dated Brent, the internationally used benchmark set in London, slipped 6%.

But this was just another example of how herd mentality can impact commodity prices. Investors, spooked by the unfolding events and spurred on by the talking heads, merely overreacted.

Here’s my take on the three panic triggers that prompted yesterday’s oil price decline…

The Greek Tragedy Continues

The first trigger that sent oil prices lower was the Greek debt crisis. This mess reached its latest pinnacle (or trough, depending on one’s view) with a public referendum on Sunday in which over 60% of Greek voters defied the European Union, the European Central Bank, and the International Monetary Fund (the so-called “troika”) by resoundingly rejecting any further austerity measures.

The decision shocked lots of people (including me). It was a clear statement of national pride and frustration.

Unfortunately, aside from bravado, it accomplished nothing. In fact, by removing the only proposal from the table (made by the European creditors), the referendum leaves no basis for any negotiations. And the clock is ticking.

At least the lightning rod for European criticism (and in some quarters absolute hostility) – Yanis Varoufakis – is gone as Greek finance minister. He is replaced by another English-trained economist, Euclid Tsakalotos.

Now, I happen to know and have worked with Euclid from his days at the University of Athens. An earnest and capable academic theorist, he nonetheless has the same problem everybody else has in this government. Until rising to office, they have had absolutely no experience in international negotiations.

Greece already defaulted on an IMF interest payment last Tuesday, forcing banks to close for a week and counting due to lack of euros, and in two weeks faces a huge €3.5 billion payment to the ECB. If Greece doesn’t make that payment, its last lifeline will be cut and the Greek banking system will collapse. To say these are desperate times is an understatement.

A rising number of investors are simply writing Greece off, assuming they will leave the euro zone. Attention is now directed to the fear of contagion should the situation unravel further. One matter to keep in mind is that while Greece owes more money to Germany (€56 billion) than anyone else, it also owes €38 billion to Italy, €28 billion to Spain, and €12 billion to Portugal. Greece’s failure to pay will further weaken these other vulnerable economies.

Are these other “weak sisters” of the EU’s southern tier likely to follow suit?

The oil market hates such a toxic combination of uncertainty and volatility.

Uncertainty Over an Iranian Nuclear Accord

Second, there is Iran’s nuclear talks. I treated the major issues surrounding this matter in an Oil & Energy Investor last week (“How the Iranian Nuclear Deal Will Impact Oil,” July 2). As I wrote then, the Iranian oil sector is in such shambles it will take some time before any significant new volume comes online.

Even then, any Western agreement will spread the lifting of sanctions over time to require Iranian compliance at benchmark intervals.

And then there is the actual damage should any significant new oil make it to the market. As I will explain when and if this occurs, the primary loser will not be other OPEC members. It will be Russia. Stay tuned for more on this issue.

But a deal is unlikely. An 11th-hour demand from the Iranian supreme religious leader that U.N. sanctions against Tehran’s ballistic missile program and weapons exports also be lifted will be rejected by the West out of hand. These sanctions actually predate the nuclear concerns and address Iran as a sponsor of global terrorism.

This demand is enough by itself to scuttle the talks.

But even the chimera that 1) a deal will be struck; 2) it will allow Iran to move oil immediately into the international market; and 3) somehow Iran will ramp up production at very old and disheveled fields is enough for the experts to pound the oil price.

China’s Stock Market Slip

Finally, there is the China factor. The Shanghai Composite Index (SCI) has been clobbered recently, down over 30%. A move to pump liquidity into the stock market by the government in Beijing combined with principal domestic investors and institutions will offset some of the concern.

But the concern being expressed from the outside is one of a stock market sell-off reflecting a leveling off of Chinese economic expansion. There are, of course, no instant figures to justify this.

No matter, pundits will posit it anyway.

On the other hand, the stock market drawback could simply be an overdue correction. Even with the hefty losses of the last week, the SCI is still up more than 83% in less than a year.

The real reason for all of this angst is this. The argument runs that any one of these three factors will temper market demand for oil and oil products, thereby keeping prices from rising. Should all three collide at the same time… well, there’s an end-of-the-world-as-we-know-it script in there somewhere.

But as you can see, they won’t all happen at once.

They can’t, since two of them aren’t even real.

The price of oil will not stay here, of course. It will inevitably rise, although in a “ratcheting pattern,” with dips and plateaus along the way.

The depth of yesterday’s decline was an overreaction. But it continues to show how spooked investors (and the pundits leading them about) actually are.

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