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Iran And North Korea: Is The Geopolitical Risk Premium Back?

North Korea - Iran

It’s difficult to ascertain what non-OPEC, and even some OPEC members, will do about future supply cuts. According to energy trader, Martin Tillier, “90 percent compliance is a good sign for OPEC, but Venezuela, UAE and Iraq aren’t following commitments.” Contrary signals are also coming from Nigeria and Libya. Libya is a wildcard due to the Misrata militia, the Libyan National Guard, and Government of Nation Accord all struggling for power. New specters of doubt have also been raised about whether Nigeria will be able to deliver the vast amounts of new oil to the market that it had promised.

Although OPEC has reported a respectable compliance rate, prices are still struggling to reach the $60-70 range because of oversupply concerns. The market is having a tough time finding equilibrium, and U.S. shale producers are now ramping up production, causing prices to stay in the mid-50s. These are all interesting aspects of energy markets, but there are other factors to consider.

What investors should begin concerning themselves with, more than President Trump’s energy policies, shale producers, and OPEC compliance, are the two dynamics that could make oil jump significantly in the future – the geopolitical rumblings coming from Iran and North Korea.

These geopolitical-investment risks are financial pieces not being mentioned enough for WTI and Brent. Both countries have shown belligerent signals in the last couple of weeks, and while this doesn’t bode well for consumers, it could prove to be a financial windfall for the oil and gas industry.

Recently, the National Iranian Oil Company (NIOC) reported the discovery of multiple new fields, holding up to 30 billion barrels of oil. Currently, Iran is already ramping up exports to Europe in spite of other OPEC members cutting back on exports. Iran is now nearing an oil production of around 4 million bpd.

Higher exports and increased oil production gives Iran billions in additional resources to fund its military and controversial ballistic missile program. However, the major uncertainties for energy markets are whether the Iranians continue flouting United Nations (UN) ballistic missiles sanctions. This geopolitical event, by a powerful nation and member of OPEC, reveals the underlying significance and implications of future energy developments.

For investors, the Iranians are not the pre-sanction weakling they once were, but instead, are a rising global energy powerhouse with the means and capability to develop any type of military weapon system they deem necessary for the regime’s survival.

The western world and Iran began pursuing détente towards normalizing relations in 2015 with the nuclear weapon agreement between the P5 + 1. Markets welcomed those stabilizing signals, but that isn’t the case anymore. Iran is now a Middle East hegemonic force that must be understood by oil and gas investors and firms.

Nicholas Hereas of the Center for a New American Security believes:

“In order to confront Iran or push back more fiercely against it, you may find you’re in a conflict far more far-reaching and more destructive to the global economy.”

This plausible scenario could cause oil markets to return to the days when wars in Iraq, Sunni-Shiite tensions, and Hezbollah fighting Israel in Lebanon caused oil to rise above $100 a barrel. Only focusing on supply and E&P profitability, without considering geopolitical-investment risk, could either be a boon or a curse depending on your position. Hedge funds have taken long bets on oil rising, but wars and conflicts cause markets and governments to move in unforeseen ways.

This is why The Institute for the Study of War in a recent report said:

“For the first time in its history, Iran has developed the capacity to project conventional military force for hundreds of miles beyond its borders. This capability, which very few states in the world have, will fundamentally alter the strategic calculus and balance of power within the Middle East.” Related: OPEC Ready To Cut Deeper

The abovementioned developments could increase the geopolitical risk premium on oil for energy investors, and markets overall. Having an investment risk equation that doesn’t account for how Iran acts in the Middle East, now that their influence stretches from Tehran to the Mediterranean, while simultaneously fighting conflicts in Syria, Iraq, and Yemen seems misguided. Unfortunately, political risk and production are now equal partners when it comes to Iran and oil prices.

North Korea is never mentioned in relation to oil prices, but could be the biggest reason oil prices skyrocket. Thae Yong-ho, one of the highest-ranking officials in the North Korean government to ever defect ardently, believes Kim Jong-un would attack the U.S. with nuclear weapons if his regime were on the brink of failure. Mr. Yong-ho elaborates:

“His ability to wreak harm should not be underestimated if his very survival were threatened he would lash out and destroy whatever he could and once there was an effective nuclear arsenal the leader would be prepared to use it.”

In early February, North Korea tested a ballistic missile which could be used to further its quest for an intercontinental ballistic missile (ICBM). A U.S. Pentagon spokesman, Navy Captain Jeff Davis stated:

“North Korea openly states that its ballistic missiles are intended to deliver nuclear weapons to strike cities in the United States, the Republic of Korea (South Korea), and Japan.”
For investors to not imagine, or have developments built into your investments where North Korea has the ability to strike major oil producers and consumers doesn’t seem shrewd. The difficult part for oil and gas investors are how to measure into your portfolio the advancement of the North Korean missile program.

Additionally, China is now angered that North Korean and Iranian sanctions placed on those countries have affected Chinese firms. China has close economic and diplomatic ties with both countries, but particularly North Korea, with whom they share a border. North Korea needs China since they are its biggest trading partner, along with its main source of food, arms and energy. Despite all this, China has allowed North Korea to continue multiple nuclear tests, and doesn’t appear likely to stop them anytime soon. Related: Is The Bakken A Bust?

Long-arching trends have been building up between North Korea and western-aligned nations for decades. At least Iran has OPEC and Russia to influence its political agenda, but North Korea only has China to keep it from having a negative enduring impact on the global economy. It is hard to imagine that China would allow North Korea to fire off an ICBM if it would have a lasting impact on the stability in the region, inflicting serious economic damage upon the Chinese economy. The South China Sea standoff is just one example of confrontational geopolitics and economic trade colliding – and the results could be disastrous – unless properly managed.

Relative oil and gas price stability has returned since prices have risen in the last few months, but 2017 could see energy upheaval along with too much supply. Geopolitical turmoil could cause everything within the energy value chain to wildly escalate; catching investors and energy firms flat-footed, the way the housing crisis in 2008 caught many banks off guard. The economics of oil and gas can manifest frustration in many ways, but what shouldn’t be overlooked, is how Iran and North Korea are impacting the geopolitical risk premium for markets.

By Todd Royal for Oilprice.com

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