Why oil prices remain low despite Middle East crisis

Over the past three months, global oil prices have surprisingly remained low between $60 and $65 per barrel (Brent benchmark) despite continued hostile incidents in and around the Persian Gulf - the waterway which transports nearly 25 percent of global oil supplies. I use the term “low prices” as a relative comparison with over $100 prices experienced in periods prior to 2014.

One would have expected the ongoing geopolitical crisis in the Middle East to push oil prices upwards, fuelled by fear of potential supply disruptions. For prices not to have increased is an indication that the world has a reasonably sufficient oil buffer that insulates the market from real or speculative shortages.

Iran oil exports have in the past one year dropped from about 2.5 million barrels per day (bpd) to 0.5 million bpd , while Venezuela (under US sanctions ) and Libya civil war have reduced their production and exports. The enlarged Organisation of the Petroleum Exporting Countries (Opec) group has also continued with reduced oil production. It is the increased US shale oil production that is making up for global supplies shortfalls, thus maintaining a near stable supply, demand, and price parity.

The current lull in oil prices can however be upset by the geopolitical tensions in the Persian Gulf, which as of now remains very unpredictable. If the current US-Iran stand-off escalates into a military activity that makes passage of crude oil tankers through the Gulf unsafe, then it will be a different story. With as much as 25 percent of global oil supply put into jeopardy, prices in excess of $100 cannot be ruled out. This is the worst case scenario.

Let us look at how the Middle East situation has evolved. It all started in 2018 when the US unilaterally abrogated the 2015 Iran nuclear agreement followed by re-imposition of economic sanctions on Iran by the US. It appears as if President Trump’s game plan is to systematically weaken Iran economically to a level that the country is forced to re-negotiate a new nuclear deal.

When Trump mentioned that his objective was “zero” Iranian oil exports, the Iranians responded that they will not sit back with zero exports while the other gulf nations exported their oil — a veiled threat that Iran was likely to interfere with passage of other oil exports through the gulf.

Over the past three months it has been a retaliatory cat-and- mouse game in the gulf area with minor attacks on tankers, drone incidents, and last week we saw actual seizure and detention of two oil tankers involving Iran and the UK, incidents which have brought in other players into the Middle East oil conflict. The safe passage of ships through the Strait of Hormuz has become a global concern.

Even those countries which are deemed to be Iran friends are not ready to touch Iranian oil for fear of US secondary sanctions which target to punish any country or company that dares transact with Iran, especially in logistics and dollar related financial services. The primary and secondary sanctions have economically weakened and isolated Iran to a level that may prove unsustainable and risky.

So far, extreme caution and restraint by both the US and Iran have been maintained by both sides, as the two appear to size each other to see who will blink first. And this critical point appears to be approaching and may escalate into retaliatory military actions with unintended consequences. Then, the worst case scenario will have been unleashed.

The Middle East crisis is proceeding in parallel with another conflict - the ongoing trade wars between China and US. The trade disputes are expected to soften global oil demands as uncertainties hit global trade and industries. As demands reduce, pressure on supplies reduces, thus increasing stocks buffer and further keeping the prices low.

Here in Kenya, the minor retail price adjustments we witnessed in mid-July are a reflection of a mild up-down global price change within the $60- $65 bracket. The Persian Gulf crisis is yet to significantly impact prices, although this cannot be ruled out in the future.