Call it a patriotic rally, a statement of resolve, poking a finger in the eye of ISIS, or simply a market responding to a threat, but yesterday’s advance said something about how investors viewed the impact of events in Paris.
Terror will not dictate Western markets.
Not too long ago, the horrific events of last Friday would have caused an immediate (and appreciable) spike in crude prices. Traditionally, destabilizing or threat-inducing actions on the international stage have increased the uncertainty factor, fueled volatility, and prompted a move to cover shorts.
True, yesterday posted a 2.5% increase in crude prices for both West Texas Intermediate (WTI, the oil benchmark traded in New York) and Dated Brent (the equivalent and more widely used global benchmark set in London). But this morning, both grades of oil were moving down.
Whatever happened to the geopolitical factor in pricing?
There are really only two effects ISIS will have on the oil industry…
Today, Supply Drives Prices
In the current market climate, ISIS and other terrorist groups have a more limited impact on oil pricing than they would have had as recently as only 18 months ago. That’s because we are in a very different environment.
These days, price increases are dependent primarily upon what occurs on the supply side of the equation. Of course, moves in either direction on the demand side would also have an impact. But worldwide consumption is not simply steady; it is increasing again with projections of the highest daily levels on record by the end of this year.
The restraining factor is all about supply. As I have observed here in Oil & Energy Investor on multiple occasions, the global oil glut is largely a result of huge unconventional (shale and tight) production (along with mushrooming extractable reserve volumes).
That means the only geopolitical signal likely to push prices up is one that calls the sourcing and supply of oil into question. Friday’s tragedies in Paris, while horrific and terrifying, did not do this. As a result, the pricing pop is reversing today.
However, keep your eyes on two supply developments that will be forming.
ISIS Needs Oil Revenues
First, ISIS needs its own oil revenues to fund an agenda.
In a report I wrote a decade ago, I calculated that a terrorist organization needed at least $14,000 to support each fighter. And that was without the cost of equipment, armaments, or other expenses directly related to the operational side. That figure is no doubt even higher today.
ISIS has a huge war chest, provided by everything from currency stolen from bank vaults in places overrun to the more staple terrorist funding from kidnapping, extortion, and blackmail. Nonetheless, it requires a considerable daily revenue flow from the sale of oil harvested from occupied fields.
ISIS sells this oil on the black market at significant discount to normal trading prices. Some of the oil is now going for $25 a barrel. Attacking the wellheads is one option here, although the ability to eliminate production rather than simply damage it is a very difficult thing to accomplish in practice.
ISIS volume, in turn, is providing an immediate glut on a regional market. Most of it is being moved into Turkey and has had an effect for some time on retraining prices in trading hubs like Dubai (where futures pricing actually includes a factor reflecting the smuggled oil).
Now, these cretins are hardly savvy traders. They dump what oil they have available without regard to market conditions.
Their Achilles heel, on the other hand, is found in the transport of that oil. This is accomplished by trucks since ISIS has no pipelines or ocean tankers. Each of these could be interdicted easily at the reception point anyway. And the trucks have become a primary target for U.S. and other airstrikes.
Interruption of “Blood Oil” Will Impact Oil Prices
Pressure is also being applied against Ankara, obliging Turkish authorities to patrol their own borders. Until recently, there was pushback. Turkey has been reluctant to enter the fray in neighboring Syria even when that has included fighting in border towns. That is now changing.
With a treasury estimated in the billions (maybe trillions), ISIS will not go away if it cannot move oil. But it will be hampered in funding foreign attacks. It already needs to resort to inefficient ways of moving money since it has no international banking system of any consequence.
The interruption of the “blood oil” flow will have a modest impact on improving overall oil prices.
The second consideration is more direct.
The Saudis Will Need to Ease Production Levels
As ISIS continues to solidify its presence in the Persian Gulf, bringing Iran into the contest in opposition, the Saudi position is now under siege. Riyadh requires further assurances from the West and regards the atrocities in Paris and the downing of the Russian passenger plane over Sinai as providing the opportunity.
On the other hand, this is likely to require Saudi easing of the current OPEC high production levels (to maintain market share). There is some movement already under way on this front, with a more direct influence on global prices.
In three weeks, I’ll be in the Persian Gulf and will be bringing you along for the ride. However, first things first. Next week’s edition of Oil & Energy Investor will be coming to you from the jungles of Brazil.
Until next time…
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