Discord between Iran and the West makes for attention-grabbing headlines, but crude-demand fundamentals are soft. So any price spikes will be temporary. The U.S. benchmark contract fell nearly 3% on the week.
Discord between Iran and the West makes for attention-grabbing headlines. And it may briefly lift oil prices, depending on its rancor. Investors can relax, however: Brinkmanship aside, depressed demand fundamentals and back-up supply will keep price jumps short-lived.
The U.S. has recently taken new measures to target Iranian oil-industry financing, in the wake of an International Atomic Energy Agency report accusing Iran of developing nuclear weapons—which Tehran denies. The European Union has promised an imminent import ban. And oil-rich Iran has been threatening to shut down the Strait of Hormuz, through which a third of the world’s seaborne oil passes, in retaliation for sanctions. On Thursday, however, news reports said that the EU is holding off its decision for six months. That pushed prices down nearly 2% for the day. Nymex-traded benchmark crude dropped 2.8% on the week, to settle at $98.70 a barrel.
Analysts say that prices could spike as much as $20 a barrel in short order, if Iran chokes off supply through the strait. But production increases from other members of the Organization of Petroleum Exporting Countries and the release of crude from the world’s strategic oil reserves would help override any short-term squeeze. And the presence of U.S. navy ships in the Persian Gulf should limit supply disruptions. Add in sagging U.S. demand and anxiety over Europe, crude prices are likely to head lower for the next few months. « Saudi Arabia alone would be able to replace Iran’s crude to Europe, » Citigroup’s energy team says in a note to clients.
THE STRATEGIC RESERVES—crude held in storage in case of emergencies—total nearly 1.6 billion barrels, according to the International Energy Agency. That’s enough to replace the 17 million barrels flowing daily through the Strait of Hormuz for 94 days. But it’s highly unlikely that the Iranians could keep the strait blocked that long. The U.S. has a flotilla of warships in the area, and is emphatic about keeping those sea lanes open.
« We have made it very clear that the United States will not tolerate » a blockade, U.S. Secretary of Defense Leon Panetta said last week. « We will respond to them. »
As anxiety over Iran ratchets down, expect to see weak fundamentals continue to undermine crude prices. Demand from the U.S, the world’s largest oil consumer, is decidedly bearish. Last year, it fell by 1.6%, and is expected to rise only a modest 0.5% this year, according to the U.S. Energy Information Administration. And the EIA recently pegged U.S. gasoline use at a nine-year low. At the same time, euro-zone leaders continue to move from summit to summit without any lasting solution to that region’s debt woes, threatening to tilt the European continent into recession and further dampen oil demand.
« We maintain that underlying fundamentals are deteriorating, and this deterioration should accelerate » come the traditional spring dip in oil demand, Morgan Stanley analysts said in a recent research note. To be sure, anything could happen in the region. But the likelihood of a medium-term impact on prices by Iran is low—and the gloomy outlook for crude futures should eventually prevail.
Don’t bet against supply, demand and the U.S. Navy.