Ideas & Debate

How Middle East geopolitics impacts global oil prices

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There is a “silent” conspiracy involving oil producers, hedge fund traders and speculators to push prices back to at least $80. file photo | nmg

When I joined the oil industry in 1970 as a Shell student of chemical engineering in the UK, oil prices were about $1.7 per barrel. However, this changed in 1973 when the Arab nations suffered a humiliating defeat from the Israelis during the Yom Kippur war.

The Arab oil producers decided to use the “oil weapon” by instituting an oil supply embargo on USA and a number of European countries who had supported Israelis in the war. The oil prices immediately spiked six-fold to $11.

This is when the control of Middle East oil production and prices permanently shifted from multinational oil companies to the oil producing nations and national oil companies after a series of nationalisations. In 1973 the Middle East produced about 75 per cent of global oil supplies.

It is also when the Western economies decided to hedge themselves against future energy blackmail by the Arabs, and immediately embarked on massive exploration for alternative oil sources. They formed the International Energy Agency (IEA) to steward energy security for the developed nations.

The next significant geo-political shock came in 1979 when the Shah of Iran was deposed in a revolution led by the Ayatollah, followed by the Iran/Iraq war the following year.

The Iranian crisis sent oil prices to above $35 dollars triggering a major global economic recession which impacted Kenya significantly.

At the turn of this century, high oil demands (mainly by China) caused prices to shoot to unprecedented levels of more than $145 in 2008.

The high prices in turn caused over-investments and over-production of oil which culminated in the price collapse of 2014. Prices dropped to a low of $25 in early 2016. Today, the Middle East accounts for only about 35 per cent of global supplies.

However, these supplies are still significant enough to cause price ripples when geopolitics in the region threatens supply disruptions. To an extent, the saying that “When the Middle East sneezes, the global economies catch cold” still holds.

As we opened 2018, oil prices had shot to about $67 as the internal unrest in Iran created some concerns in the oil markets. There was also the threat of Red Sea traffic interruption by some Yemen fighters that pushed the prices further up.

However, it was the positive confirmation by the Opec (and Russia) that they will sustain the agreed oil production cuts to the end of 2018 that seem to have settled the oil price at $70, the highest level in three years.

The Middle East remains highly vulnerable to internal, regional, and international conflicts. The tension between Iran and Saudi Arabia fuelled mainly by the Sunni/Shia rivalries has prompted the ongoing proxy conflicts in Iraq, Syria, Lebanon and Yemen.

In respect of Iran, President Donald Trump is planning to undo the nuclear deal done by global powers with Iran in 2015 and this will have some ramifications on oil. The deal was expected to set Iran on a major economic (and political) recovery path with increased oil production.

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My assessment is that there is an ongoing “silent” conspiracy between oil producers, hedge fund traders and speculators to gradually persuade prices upwards back to at least $80.

Prior to the collapse of oil prices in 2014 there was a general consensus that prices around $80 were economically sustainable and sufficient enough to sustain national budgets of oil producing nations.

The Middle East conflicts, real or imagined, provide fodder for traders and speculators to urge prices to higher “new normal” levels.

Strengthening of global economies and oil demands are the other factors that support higher prices.

However, the increasing oil production, prompted by increasing prices, will work towards lowering prices as this prompts global over-supply. This is mostly the case with the Shale oil producers of USA.

Kenyan consumers will need to brace themselves for higher pump prices as new oil supplies arrive at higher import costs.

Kenyans should also closely watch the Middle East geopolitics as these always ultimately impact our pump prices.