Trump is bullish for oil
The market should start pricing in the mounting geopolitical risks
Opec's cuts and tight oil's response have dominated market rhetoric since November. But Donald Trump's presidency and its capacity to upturn geopolitics are now at least as significant for price direction. No wonder the smart money on Wall Street has been piling into crude.
Most of oil's price slumps of the past 45 years ended with a geopolitical crisis. Before each, the market assumed the world was amply supplied, and would be indefinitely - and ignored the disruptive potential of politics.
This is true again now. You can buy a barrel of oil for delivery in December 2019 for $56.47 a barrel, or about $0.40 less than the near-term contract on the Intercontinental Exchange. Baked into this futures curve is an underlying faith that any price rises will be capped by the response of US oil producers.
But in risk terms US foreign policy can trump all that. Start with Iran. More US sanctions are reportedly imminent. New National Security Adviser Michael Flynn's first statement was to say the US was "putting Iran on notice" for launching a ballistic missile. It said too that Iran had "trained and armed" Houthi rebels in Yemen. "The Trump Administration condemns such actions by Iran that undermine security, prosperity, and stability throughout and beyond the Middle East and place American lives at risk."
Trump pledged throughout his election campaign to undo the nuclear deal Iran signed with the international community. If he does - and the world is learning that he meant what he said - it will embolden Iran's hardliners (who already rage that some US sanctions remain in place). Things could worsen fast.
Anyone who watched the US build a case for war in Iraq in 2001-03, using dubious assertions and false claims, will wonder about the White House's plan now. There is little evidence, for example, that Iran is training Houthi rebels. Yet "Iran is playing with fire," tweeted @RealDonaldTrump on 3 February. "They don't appreciate how 'kind' President Obama was to them. Not me!"
This is all being cheered in the Arab Gulf. But oil markets should not be sanguine about the consequences. Iran has added about 1m barrels a day to supply since some sanctions were lifted in early 2016. The market could cope with a reversal. But war, if it came to that, may shut the Strait of Hormuz and further destabilise Iraq, among other problems. Oil prices would spike, whatever was happening in the Permian.
Steven Bannon, supposedly Trump's most trusted advisor and his chief strategist, talked last year of conflict with China within the next five to 10 years (he also predicted another war in the Middle East). Trump has already enraged Beijing with accusations of currency manipulation and threats to impose tariffs. The US' One-China policy has been a cornerstone of its relations with China since the early 1970s, and is a red line for Beijing. Yet in January, Trump said "everything is under negotiation, including One-China".
Other shifts in US policy may also have unintended consequences. Moving the US embassy from Tel Aviv to Jerusalem would be inflammatory across the region - US allies in the Middle East are lobbying Trump not to do it.
Ditching the US' support for the UN-appointed Government of National Accord in Libya could easily result in all-out war between the exiled government in the east and Islamist groups in the west - the oil assets of the Sirte basin would sit in the middle. Yet, after Trump's ban on travellers from Libya and six other Muslim countries, that move looks probable, possibly as soon as the president learns that the UN had to rely on Islamist groups to establish its unity government in Tripoli.
All of this presents huge new geopolitical risk to oil markets. Some in the industry might welcome the price inflation it implies - but demand has only just regained its trend growth and another spike would only deliver good news for oil's alternatives.
None of it - war with Iran, war with China, more war in Libya - is inevitable. Rex Tillerson's role as Secretary of State in navigating the USS Trump away from these disasters will be critical. Allies in the Gulf need to be a restraining voice, especially on Iran.
And while the geopolitics look staunchly bullish, bearish forces also abound. The huge stock overhang - OECD inventories remain about 300m barrels above the five-year average - is one.
Another is Opec. The corollary of its cuts - an attempt to deal with this supply surplus - is that the group has, at least on paper, recovered a little of its spare capacity (see graphic). In case of a supply disruption, Saudi Arabia alone could pump another 0.5m barrels a day almost overnight (returning to its pre-cuts levels) and still be 1.7m b/d beneath what it says is its technical capacity.
Other lurking downside risks include a bout of protectionism that weakens global GDP growth; a breakthrough in non-oil transport technology; or electoral shocks in France and Germany that disrupt the EU and strangle its economy. Each could hurt oil demand. If so, Opec might cut again to shore up prices, leaving it with even more spare capacity.
But conflict is usually the way out of oil-market weakness and the potential is higher now than it was two months ago. Whatever else you think of Trump, the early bent of his foreign policy and the dawning notion that he plans to do the things he promised must make you sit up. No one should expect the next four years to pass without a new war or another geopolitical crisis. The oil market should start pricing that risk.
* Implied by 100% compliance with cuts
* Note: Includes all members. Indonesia did not operate any spare capacity and its membership and departure did not affect overall number