09-11-2017

The Return of the Geopolitical Risk Premium

The recent Iraq-Kurdish conflict heralds the return of the geopolitical risk premium in oil prices. While the ongoing rally in crude prices is underpinned by fundamentals such as robust demand growth, ongoing OPEC supply cuts and falling US crude inventories, growing tensions in the Middle East have been playing an increasingly significant role. With Iraq seizing control of the disputed Kirkuk region on 16 October, Brent crude futures jumped to a three-week high of $57.82/bbl as production at two major oilfields was shut. According to Bloomberg, Kurdish crude exports fell by around 300 kb/d in October due to supply disruptions.

Spurred by the sudden and unexpected purge in Saudi Arabia, oil prices surged to their highest in two and a half years as Brent crude futures crossed the $64/bbl mark on Monday. The anti-corruption crackdown is viewed by many as a move by Crown Prince Mohammed bin Salman to further consolidate his power at home as he pushes through major reforms such as Vision 2030, which includes the Saudi Aramco IPO. Concerns over potential instability in the Kingdom and investment climate have added a geopolitical risk premium to oil prices. If anything, the Saudi purge can be viewed as bullish for oil prices as it further cements Saudi Arabia’s commitment to reduce the global glut. Crown Prince Mohammed bin Salman has made his stance on extending the ongoing OPEC cuts of 1.8 mmb/d clear, as higher oil prices would benefit the IPO. The rollover of the OPEC production curbs for the whole of 2018 is likely to further delay any significant recovery in the tanker market, which is already facing headwinds from persistent overcapacity. Lower cargo volumes ex-AG have contributed to the drop in average VLCC earnings this year, which are currently around 40% less than that of 2016. The backwardated market structure has also led to the ongoing decline in VLCC floating storage, which has released more tonnage into the trading fleet.

Source: OFE Insights

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