OILX - What A Rise In Geopolitical Risks Could Mean For Oil Prices
2023-10-13 02:30:00 ET
Summary
- The potential impact of the Israel-Gaza conflict on energy markets.
- Why Iran's oil production has been rising.
- Geopolitics and commodities. What to expect.
The conflict involving Israel and Hamas in Gaza has been raising concerns about stability in the energy sector. Greg Bonnell speaks with Hussein Allidina, Head of Commodities at TD Asset Management, about the potential impact of the crisis and the implications for energy markets.
Greg Bonnell: The conflict involving Israel and Hamas in Gaza has been raising questions about the stability of the energy sector, especially amid fears of a broader Middle East violence. Hussein Allidina is head of Commodities at TD Asset Management. Joins us now for some perspective. Hussein, obviously it's been a pretty startling chain of events over the last several days. And the oil market reaction has been curious, as well.
Hussein Allidina: It has been, for sure. I guess very depressing situation that we're seeing in the Mideast. I think from a oil perspective, yeah, we saw the market rally on the open on Sunday on the heels of the attacks on Saturday. The market has retreated a little bit of late. I think, from a supply/demand point of view, clearly, there isn't production at risk in Israel or Palestine.
You do have the potential for this situation to escalate if Iran gets involved. Iran is producing and exporting more oil than they have in the last five years, north of 3 million barrels a day. So there is some risk there. Hopefully, that is a sort of tail event, a worst-case scenario. But I think given the tightness in inventory, given kind of how fragile the balance is right now, it likely makes sense to embed a bit of risk premium around that.
Greg Bonnell: Is that sort of what the market's trying to figure out right now? And obviously, these are early days, but the events are moving quickly, as well. But you can't really just come to a thesis at this moment and say this has happened, so this will happen, so this will happen. It's very fluid.
Hussein Allidina: It's extremely hard. I think when we go back and look at prior events, so a few years ago, we had the drones that attacked the refinery in Saudi. You saw the market trade up pretty meaningfully. Typically, these supply disruptions, when they occur, are not long-lasting. So you see that premia come out. But there have been instances, which I'm sure are fresh in the minds of some, where you've seen material reductions in production.
So 50 years ago, the Arab oil embargo contributed to sending oil prices from $3 a barrel to $15 a barrel. So there is some of that risk in mind. When you look at balances and you look at the production that is at risk right now, it is very minimal. I do think that the events that have unfolded over the weekend temper the likelihood of a rapprochement between Israel and Saudi, which was something that the bears had been talking about as we look to year-end and into 2024.
And I mentioned Iranian barrels. Iranian production has been a source of supply to the market. And there is potential for those sanctions to be sort of -- the sanctions never disappeared, but I think the US kind of turned a bit of an eye. And you might see some of those volumes come off, which the oil balance really can't afford.
Greg Bonnell: Yeah. We're showing the audience right now a chart that you brought along about oil production in Iran. And clearly, I mean, from the timeline here, there definitely has been a ramp-up.
Hussein Allidina: There's been a material ramp-up. And that's part of the reason that the draws that we have seen have not been more pronounced. I think that if that production is at risk, which I think the market, as you mentioned, is trying to figure out, it paints a very constructive picture. But again, supply-induced shortages are not great for growth, are not great for inflation. Very different than prices going higher because of a demand surprise.
Greg Bonnell: Now, we have seen a situation, too, you mentioned Saudi Arabia, the fact that they have been constraining production to meet their aims and goals. If you ended up in a situation where, say, Iranian barrels are taken off the market, you think you have a tighter market, what would Saudi Arabia perhaps do about that?
Hussein Allidina: So I think the good thing about where we are today is that Saudi Arabia, Kuwait, UAE, and some of the Gulf countries have reduced production intentionally. So their spare capacity, OPEC spare capacity is probably north of the 3 million barrels a day that Iran is producing right now. So ultimately, if there was a disruption, I think that you could see an increase in production from Saudi and some of the other Gulf countries to alleviate that disruption.
Ultimately, though, as spare capacity falls, the market worries, because if there is another disruption, then there is no buffer to meet that. But absolutely, if you lose Iranian production, Saudi could increase their production to mitigate that loss, I think.
Greg Bonnell: Also, if we were having this discussion only a couple of weeks ago, or maybe only last week, we would be talking about the broader global economy. You get different global agencies pulling back their growth forecasts, saying words like tepid. Usually, that plays into the oil trade. Does that get further complicated into this mix about worrying about demand if this recession that I think you and I have been talking about, and all the other people we've had on the show have been talking about, for a year and a half actually shows up?
Hussein Allidina: Yeah. And I think, look, if oil prices are moving higher because of supply-related concerns, that is not great for growth. I think the thing that we have to keep in mind from a commodity perspective, oil demand is expected to decline next year; the demand growth. The absolute level of demand, though, on most forecasts is still above supply. And that still, on a full-year basis, portends to inventory draws.
So again, in equity land and fixed income, we talk a lot about the second derivative, the rate of growth. That is important for commodities. But if oil demand slows, but not enough to kind of fall below supply, then I'm still drawing inventories. And that's still a constructive backdrop.
Greg Bonnell: We may actually talk about this a bit later on, but I wanted to squeeze this in right now because, apart from everything and the very important things that we've tackled so far in this conversation, we actually have some M&A activity...
Hussein Allidina: Yeah, we do.
Greg Bonnell: ...in the oil and gas sector. I wanted to get this one on Exxon ( XOM ). This is their biggest purchase, I guess since they became Exxon Mobil.
Hussein Allidina: It's interesting. So Exxon is definitely growing their reserve base, growing their production profile, but they're doing so by acquiring Pioneer ( PXD ). That's great for Exxon, potentially great for Exxon shareholders, but does not change the oil balance, right?
Exxon could have said, look, we're going to go look for incremental upstream production in the Permian or offshore, Guyana or wherever. Instead, they've decided to buy Pioneer. There might be some implication as to, well, it's easier to buy a company than it is to grow production in this environment. And I think that's telling.
Greg Bonnell: Let's get into that. That is telling, in the sense that we've seen all these oil and gas majors returning money to shareholders. And now they're making acquisitions, but as you said, an acquisition that doesn't actually grow global production numbers.
Hussein Allidina: Yeah. And look, at the end of the day, we've talked about this before -- we have to be able -- if we believe in GDP growth, that GDP growth still requires oil demand. That dialogue, that narrative has been broken. People think that oil demand is peaking.
Oil demand reached record highs in July and August of this year, notwithstanding the fact that the economy hasn't been as robust as we thought, notwithstanding the fact that China hasn't been firing on all cylinders. If you believe in GDP growth, then, implicitly, you believe in oil demand growth. In order to meet that oil demand growth, we need to be investing in the supply side. If we don't, then prices have to ration demand to find equilibrium.
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What A Rise In Geopolitical Risks Could Mean For Oil Prices