Dramatic initial price reaction to US-Iranian hostilities in Persian Gulf, although less than before the US shale revolution

Oil prices have had a tumultuous week since the US launched a drone attack in Baghdad, killing Iranian General Qassem Soleimani. With tensions peaking after the US and Iran traded missile attacks, oil markets priced in a risk premium. However, as long as the flow of oil barrels to the market is not affected, Rystad Energy continues to see a downward risk to prices, with further pressure on OPEC to implement even deeper production cuts in order to keep Brent oil prices around $60 per barrel through 2020.

“It is important to look beyond the rhetoric of the headlines and focus on market fundamentals – including the continued rise of non-OPEC oil supply led by US shale, and flat demand growth – which all points to a surplus, not a deficit, in oil balances in 2020,” says Bjørnar Tonhaugen, Head of Oil Market Research at Rystad Energy. “Prospects of Brent prices slipping below $60 per barrel – even in the midst of an intense geopolitical flare up in the Middle East – are entirely plausible.”

Oil prices still react dramatically to news of tensions in the Persian Gulf, although less dramatically now than they would have before the US shale revolution. The importance of the region for oil markets is obvious, given that seven Gulf countries alone – Saudi Arabia, Iraq, UAE, Kuwait, Iran, Oman and Qatar – produced around 24 million bpd of crude oil in December 2019.

“With the regime in Tehran under heavy sanctions, Iran is no longer an official major global oil producer. This means the real risk of a conflict between the US and Iran gets pushed to neighboring Iraq, where 5,000 American troops are stationed and where Iran is wrestling for political power. Any proxy war played out in Iraq would put the country’s nearly 4.7 million bpd of crude oil and condensate production as risk,” states Tonhaugen.

However, one key reason that geopolitically-driven oil price swings are now more subdued relates to the stabilizing effect of US shale oil production on global oil supplies. The stellar growth of shale has introduced a significant counterweight to the market, as it helps to absorb disruptive events such as the September drone attack on Saudi Arabian oil infrastructure and the geopolitical tensions that followed the assassination of General Soleimani.

Rystad Energy forecasts that the ‘call’ on OPEC (in other words, the market demand for OPEC oil) will average about 28.3 million bpd during the final nine months of 2020. By comparison, OPECs actual production in December 2019 was 29.6 million bpd, and the cartel’s new implied production target for the first quarter of 2020 is 29.2 million bpd.