Is Iran Preparing To Send Oil Back To $100?

Two of Saudi Arabia’s key oil sites are attacked and its oil production is more than halved but the US$70-75 per barrel of Brent oil barrier holds firm. The U.S. assassinates the most important man in the most volatile regime in the Middle East but the level still holds firm. Iran retaliates with missile attacks against the U.S. base [Ain al-Assad] in Iraq but the cap remains unbreached. The U.S. has gone to great lengths to put a serious lid on the oil price at this US$70-75 per barrel of Brent level for the economic political reasons analysed below, supported by a variety of means also examined below, but retaliatory moves being planned by Iran for the execution of Major General Qassem Soleimani by the U.S. might blow through the cap and even through the key US$100 per barrel of Brent resistance level.

The importance of the US$70-75 per barrel level is that it is a heavily protected barrier to any sustained moves to and through the US$75-plus per barrel level, which is a key psychological and technical resistance for oil pricing. Such a sustained move upwards would almost certainly lead to long-term stop loss short positions (and similarly short-structured options positions) being triggered and pushing oil up to and through the US$90 per barrel level and towards US$100 per barrel. Two very bad things can happen for U.S. presidents when this sort of upwards momentum around these sorts of levels starts to look sustained, especially for U.S. presidents seeking re-election.

‘Bad thing number one’ is that, according to the statistics, since World War I, the sitting U.S. president has won re-election 11 times out of 11 if the economy was not in recession within 24 months ahead of an election. Conversely, presidents who went into a re-election campaign with the economy in recession lost five out of seven times. Up until very recently, many of the smarter investment houses were predicting a fifty per cent chance of an outright U.S. recession within the coming 12 months and, although this has substantially gone down (most now see just a 10-15 per cent chance of such an event), the point is that a upwards-spiralling oil price could change this probability very quickly indeed, and U.S. President Donald Trump knows this. Related: Russia Risks Gasoline Price Surge

In this context, according to the American Automobile Association in Washington, for every cent that the national average price of gasoline rises, more than one billion dollars per year in discretionary additional consumer spending is estimated to be lost – ‘bad thing number two’. At the moment, the price per gallon of gasoline at the pumps in the U.S. is around US$2.66, whilst the ‘danger zone’ for U.S. presidents starts at around US$3.00 per gallon; at US$4.00 per gallon, they are being advised to pack their bags in Pennsylvania Avenue or start a war to divert the public’s attention. The point was underlined by Bob McNally, the former energy adviser to the former President George W. Bush that: “Few things terrify an American president more than a spike in fuel [gasoline] prices.”

As a general historical rule of thumb, it is estimated that every US$10 per barrel change in the price of crude oil results in a 25-cent change in the price of a gallon of gasoline. Based on more recent historical precedent, a US$90-95 per barrel of Brent oil price equates to around US$3 per gallon of gasoline and a US$125-130 per barrel of Brent equates to around US$4 per gallon of gasoline.

This is the principal reason why whenever there has been a spike in the global benchmark Brent oil price (and corollary WTI price, which tends to trade at an historical discount of US$5-10 per barrel to Brent, and is currently at a discount of around US$6.00 per barrel) the ‘Trump price cap comment’ kicks in. The full effect of this was illustrated last May when oil prices started to spike up decisively on news that the U.S. was to withdraw from the Joint Comprehensive Plan of Action with Iran and to re-introduce sanctions against it. WTI was spiking through the US$65.00 per barrel level, and Brent through US$70.00, when Trump Tweeted: “Very important that OPEC increase the flow of Oil [sic]. World Markets are fragile, price of Oil getting too high [sic]. Thank you!”

Since then, whenever there has been a spike close to or even temporarily through the US$70.00 per barrel level of Brent, Trump has Tweeted, texted and telephoned in various inducements or threats to various entities with a stake in the oil price. These include U.S. shale producers, Norway, Brazil, and Canada (produce more), the core U.S. investment banks that are also part of the U.S.’s interest rates market control group (sell oil through the forwards and futures markets at and around the US$70 per barrel of Brent level) and Saudi (produce more and if you cannot then do not publicly sanction others at the time, like Iraq, Abu Dhabi, Kuwait and the rest for breaking their OPEC production quotas). Related: Could ISIS Take Control Over Iraq’s Largest Oil Field?

Just in case Saudi Arabia ever forgets what is at stake if it does not toe the U.S. line, then Trump helpfully reminded it in October: “We protect Saudi Arabia...And I love the King, King Salman. But I said ‘King - we’re protecting you - you might not be there for two weeks without us…’.” This references the very basis of the U.S.-Saudi relationship since 14 February 1945 when the then-U.S. President Franklin D. Roosevelt and the Saudi King at the time, Abdulaziz, had their first face-to-face meeting on board the U.S. Navy cruiser Quincy in the Great Bitter Lake segment of the Suez Canal. The deal they agreed – analysed in depth in my new book on the oil markets - that persisted completely unchallenged until the Oil Crisis of 1973 but was then resumed, was this: the U.S. would get all of the oil supplies it needed for as long as Saudi had oil in place, in return for which the U.S. would guarantee the security both of the country and of the ruling House of Saud.

At the same time, Trump can rely on Russia to do precisely what it wants regarding oil production, which is to produce whatever it likes provided that it does not cause the oil price to dive. Around US$40 per barrel of Brent is the breakeven price for the Russian budget but the big oil producer bosses – notably President Vladimir Putin’s close friend, Igor Sechin of Rosneft – think the optimal price at which they can produce pretty much the levels they want without triggering a domino-effect fall in prices is in the US$60-65 per barrel of Brent range.

All of this said, Iran has not even really begun extracting its revenge for the killing of Soleimani, according to a senior Iran source who works closely with Iran’s Petroleum Ministry. “It [Iran] said that the missile attacks against the U.S. base [Ain al-Assad] in Iraq would be the end of it but obviously that’s what they would say; in fact, a lot more is likely to come,” he exclusively told OilPrice.com last week. There are two strategies that are “almost certain to happen in the next two months or so”, he added, and these are (in no particular order, as Iran will probably do both): first, launch further rocket attacks on Saudi and, second, disrupt oil flows through the Strait of Hormuz.

As exclusively highlighted by OilPrice.com at the time, the 14^th of September attacks by the Houthis/Iran on Saudi Arabia’s Aqaiq and Khurais oil facilities cut the Kingdom’s oil production by around 5.7 million barrels per day (much more than half). Contrary to Saudi claims, production is still not back to what it was before the attacks so any further attacks would have a much bigger effect on oil prices, as Saudi is already using almost everything it can from other sources to plug its supply contracts with major buyers. Further such attacks would have a true element of karma about them from the Iranian perspective, as the original attack was believed to be an idea from Soleimani, and also they would lead to a spike in oil prices that would substantially benefit Iran’s beleaguered economy.

Disrupting oil flows through the Strait of Hormuz is a tried-and-tested method of Iran to assert its influence in the world, as it is the chief artery through which around 30 per cent of the world’s oil supplies flow. It is also extremely narrow at various points so, in addition to hijacking vessels, disabling vessels, and warning ships not go through the Strait without specific permission from Iran, it would be very easy to launch further attacks from the shores through very rudimentary weapons systems. It is highly apposite to note at this point – with reference to the US$70-75 per barrel Brent barrier – that the last time that Iran seriously threatened to close the Strait of Hormuz in 2011/2012, oil prices went through US$128 per barrel, and the gasoline price at pumps in the U.S. to US$3.9970, and remained elevated for many weeks. 

By Simon Watkins for Oilprice.com

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