On Friday Hezbollah leader Hassan Nasrallah warned Israel: "You must
expect surprises from our resistance" [photo credit: Al Manar]
It is, in my view, very unlikely that the Iranians would agree to a
Hezbollah withdrawal, even if faced with a credible — possibly
existential — threat from Israel. And especially after the Iran/Israel exchanges
of last month, Iran could hardly stand by and see its main source of
deterrence defenestrated. Furthermore, if this is how events unfold —
and irrespective of timing relative to the US presidential election and
who was sitting in the Oval Office — I find it difficult to imagine that
the United States would not get drawn in, even if only (initially?) to
ensure free passage of shipping through the Strait of Hormuz.
All this being said, it remains the case that, as explored at length in the 5 March Newsletter,
we might never get to this point. And we are not, by any means, close
to it yet. But it is still worth reflecting on the fact that this is a
scenario which oil markets have been mulling — but largely discounting
to date — since 7 October. Indeed, Brent crude at just over US$82 per
barrel (pb) today — compared with US$84.58 at close of business on 6
October and US$83.98 just prior to the fatal helicopter crash — suggests
that it has become a ‘grey rhino’, i.e. a big, obvious threat which investors are largely ignoring.
Despite the fact that, even in a worst case the impact on oil output —
other than Iran’s 1.6 million barrels per day (mbpd)— would probably be
low, we should certainly expect an initial sharp price spike. However,
even in the event of continuing hostilities there would likely be a
subsequent, albeit more gradual, sell-off to somewhere close to the
status quo ante. Nevertheless, if this scenario were to unfold at pretty
much any point in the second half of 2024, my forecast for Brent crude
of US$70pb on 31 December goes on ‘hold’, if not out the window.
It is also worth keeping in mind that the demand side is not looking as rosy as it did a month ago, according to the International Energy Agency
(IEA). Its latest Oil Market Report still forecasts a rise in global
demand of 1.1mbpd through 2024; but this is 140kbpd lower than the IEA’s
April forecast. Tellingly, the report notes that:
Brent futures eased from a six-month high above $91/bbl in early
April to around $83/bbl as concerns about a wider Middle East conflict
subsided and softer macro sentiment weighed on prices.
This assessment is not entirely consistent with the ‘grey rhino’
analogy in that I doubt very much that investor “concerns about a wider
Middle East conflict” have “subsided” so much as their being sidelined
for now. However, I think it is correct about “softer macro sentiment”
especially relative to the United States, where inflationary pressures are still proving more stubborn than anticipated, and China,
where the central bank’s 17 May ‘bazooka’, intended to re-float the
underwater real estate market, has failed to impress investors.
Furthermore, a second ‘grey rhino’ is now emerging from the undergrowth. To quote the FT’s James Politi, trade is now at “the heart of this year’s
presidential contest” in the US as Joe Biden and Donald Trump look to
out-compete one another in being tough on China. While the economic
impact of the former’s 14 May package of trade measures will not be immediate, and although it is not yet known how China will retaliate (as it surely will), we are almost certainly at the thin end of a protectionist wedge which will likely act as a drag on the global economy as a whole before the end of the year.
Where does this leave me relative to my forecast for Brent? For sure,
both my grey rhinos demand a watching eye. However, to my mind, the
demand side currently outweighs the supply side risk. So, I still see no
reason other than to continue to stick to my guns on US$70 per barrel.
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