• 1 day PDVSA Booted From Caribbean Terminal Over Unpaid Bills
  • 2 days Russia Warns Ukraine Against Recovering Oil Off The Coast Of Crimea
  • 2 days Syrian Rebels Relinquish Control Of Major Gas Field
  • 2 days Schlumberger Warns Of Moderating Investment In North America
  • 2 days Oil Prices Set For Weekly Loss As Profit Taking Trumps Mideast Tensions
  • 2 days Energy Regulators Look To Guard Grid From Cyberattacks
  • 2 days Mexico Says OPEC Has Not Approached It For Deal Extension
  • 2 days New Video Game Targets Oil Infrastructure
  • 2 days Shell Restarts Bonny Light Exports
  • 2 days Russia’s Rosneft To Take Majority In Kurdish Oil Pipeline
  • 2 days Iraq Struggles To Replace Damaged Kirkuk Equipment As Output Falls
  • 2 days British Utility Companies Brace For Major Reforms
  • 3 days Montenegro A ‘Sweet Spot’ Of Untapped Oil, Gas In The Adriatic
  • 3 days Rosneft CEO: Rising U.S. Shale A Downside Risk To Oil Prices
  • 3 days Brazil Could Invite More Bids For Unsold Pre-Salt Oil Blocks
  • 3 days OPEC/Non-OPEC Seek Consensus On Deal Before Nov Summit
  • 3 days London Stock Exchange Boss Defends Push To Win Aramco IPO
  • 3 days Rosneft Signs $400M Deal With Kurdistan
  • 3 days Kinder Morgan Warns About Trans Mountain Delays
  • 3 days India, China, U.S., Complain Of Venezuelan Crude Oil Quality Issues
  • 3 days Kurdish Kirkuk-Ceyhan Crude Oil Flows Plunge To 225,000 Bpd
  • 4 days Russia, Saudis Team Up To Boost Fracking Tech
  • 4 days Conflicting News Spurs Doubt On Aramco IPO
  • 4 days Exxon Starts Production At New Refinery In Texas
  • 4 days Iraq Asks BP To Redevelop Kirkuk Oil Fields
  • 5 days Oil Prices Rise After U.S. API Reports Strong Crude Inventory Draw
  • 5 days Oil Gains Spur Growth In Canada’s Oil Cities
  • 5 days China To Take 5% Of Rosneft’s Output In New Deal
  • 5 days UAE Oil Giant Seeks Partnership For Possible IPO
  • 5 days Planting Trees Could Cut Emissions As Much As Quitting Oil
  • 5 days VW Fails To Secure Critical Commodity For EVs
  • 5 days Enbridge Pipeline Expansion Finally Approved
  • 5 days Iraqi Forces Seize Control Of North Oil Co Fields In Kirkuk
  • 5 days OPEC Oil Deal Compliance Falls To 86%
  • 6 days U.S. Oil Production To Increase in November As Rig Count Falls
  • 6 days Gazprom Neft Unhappy With OPEC-Russia Production Cut Deal
  • 6 days Disputed Venezuelan Vote Could Lead To More Sanctions, Clashes
  • 6 days EU Urges U.S. Congress To Protect Iran Nuclear Deal
  • 6 days Oil Rig Explosion In Louisiana Leaves 7 Injured, 1 Still Missing
  • 6 days Aramco Says No Plans To Shelve IPO
Alt Text

Oil Giants At Odds As Saudi, Russian Ties Improve

Oil giants Rosneft and Aramco…

Alt Text

Are Oil Markets Becoming Immune To Geopolitical Risk?

The geopolitical risk premium in…

Alt Text

New Iran Sanctions Could Send Oil Prices Higher

Fresh sanctions on Iran could…

Materials Risk

Materials Risk

Materials Risk started in January 2012 and aims to bring commodity market insights across a variety of different supply chains.The objective is to help small…

More Info

How Should Commodity Traders Now Think About Geopolitical Risk?

How Should Commodity Traders Now Think About Geopolitical Risk?

In 2009 political scientists Ian Bremmer and Preston Keat defined geopolitics as “the study of how geography, politics, strategy, and history combine to generate the rise and fall of great powers and wars among states.” Given its importance to the running of the modern global economy, nowhere is this more vividly observed than in the battle for energy resources and in particular oil.

A cursory look at a simple oil price chart reveals a series of bumps. Each of these can be pinpointed to wars and conflicts, whether it was the Iranian revolution or the first and second Gulf wars. More recently, Arab Spring related uprisings in Libya, Egypt and Syria as well as violence in Iraq and the Ukraine have resulted in escalating geopolitical tensions across many key energy production and transit countries.

Geopolitics has come back to the forefront in recent weeks following Saudi airstrikes on rebel positions in Yemen. Although there appears to be little risk of any oil production actually being affected, the bigger risk concerning the market was that the Bab el-Mandeb strait (a transit route for around 7% of the world’s crude) could be blocked and that the conflict might represent the opening exchanges of a broader conflict between Saudi Arabia and Iran. The oil price jumped about 5% on the news, only for it to give back those gains within a week. Related: Is Warren Buffett Wrong About Oil Stocks?

How should commodities be priced under conditions of high geopolitical uncertainty? As a non-income producing asset, commodities are only worth what individual people are prepared to buy and sell at any one time. Commodity markets, like every other financial market, should in theory at least, act to constantly reflect the opinions of buyers and sellers regarding demand, supply and the future direction of the price. However, they are also influenced by the emotions and the perceptions of risk of those who trade them, including producers, consumers, traders and investors. And here the key factor is the perception of scarcity.

Take oil as an example. You can say that much of it is in the hands of nations that we can’t rely on, but what does that make it worth? The same factors were just as relevant when oil was around $40 per barrel in December 2008 and they were equally true in July 2007 when oil reached $147 per barrel. In the end the commodity is only worth what someone is prepared to pay for it. The market’s perception of scarcity today in April 2015 means that traders are only willing to pay half what they paid for it a year ago. Related: Does Fracking Have A Future In Asia?

Looking for examples of what prices could do from previous events is instructive of the fear and the extent to which prices can move, but they don’t provide a hard and fast rule for how future geopolitical events will play out. Take the first Gulf war in 1990, the oil price doubled initially and then, once the US led military response started, oil prices gradually fell back so that within 9 months the spike had subsided. More recent actual disruptions to supply have tended not to result in a significant impact on prices. Only a few years ago news of a pipeline blowing up in Nigeria would have caused a sharp rise in the price of oil. High inventory levels amid a supply glut in oil and many other commodities mean that there is now a much healthier buffer stock in place against potential disruptions. The perception of scarcity is now much lower.

Geopolitical events are, by their very nature, hard to predict and are often destabilizing; in a sense they could be termed ‘black swans’ in that they are low probability, high impact events. A negative geopolitical event will tend to increase the risk premium and alter the direction of asset prices. However, when a geopolitical event also depresses economic growth and changes the course of inflation, then the effect on commodity markets is likely to be more sustained.

The effect of a geopolitical shock might also be very different from what was originally feared. Taking the example of a disruption to oil tanker traffic in the Bab el-Mandeb strait, it’s worth considering that the route is also the major route for container traffic between Asia and Europe and so any disruption would act to slow world trade and global economic growth, depressing oil demand and prices. Related: Is Ukraine’s Embattled Energy Sector A Lost Cause?

The price of a commodity whose supply is under threat from a geopolitical event will tend to increase as perception of its scarcity increases. Gold and to a lesser extent other precious metals tend to benefit in times of uncertainty. The impact on other commodity markets is more mixed. If oil supply is under threat, other commodities that are very energy intensive and so also highly correlated may also rise. However, if the broader impact results in a loss of business and consumer confidence and a slowdown in economic growth, then demand and prices for other commodities may fall.

Geopolitical events can appear to surface out of nowhere. Although we routinely focus on issues that are in our immediate field of vision, new developments that radically alter our perception often emerge out of left field. The trouble with geopolitics, however, is that it often appears as noise until it suddenly becomes a crisis. To quote Warren Buffet “In the business world, the rear view mirror is always clearer than the windshield”. As the perception of scarcity has diminished the impact of geopolitical events in today’s commodity markets is now more nuanced than we’ve seen for quite some time.

By Peter Sainsbury for Oilprice.com

More Top Reads From Oilprice.com:

Back to homepage

Leave a comment

Leave a comment

Oilprice - The No. 1 Source for Oil & Energy News