Should we be worried about unstable oil prices?
The announcement of fresh US sanctions against Iran has triggered a new wave of uncertainty in global oil prices. But what are people specifically worried about, and why are prices changing so rapidly?
As you might expect, the main concerns seem to be around supply. The initial announcement caused prices to balloon as the market assumed that there would be a shortage; Brent crude oil rose to more than US$86 a barrel in response, its highest level for four years.
However the market has settled since then for a few reasons. Probably the most important calming measure was the USA issuing waivers to a limited number of companies to continue trading with Iranian oil firms. Countries including China, India, South Korea, Japan and Turkey are among those allowed to purchase from Iran, and whilst production has slowed to 1.8 million barrels a day there is still a significant amount of oil coming out of the country.
In addition, American oil production has increased at a faster rate than expected, Saudi Arabia has upped its production to near-historic levels and Russia continues to pump oil at extremely high rates. These factors have mitigated concerns about supply for many.
However, this heightened production comes with issues of its own; if the balance tilts too far the other way and there is too much supply then prices are likely to fall. Planning ahead for this possibility, Opec and Russia have agreed to maintain supplies at the current levels to avoid the risk of economic uncertainty in the sector. They are expected to act proactively in this regard.
The final factor which is playing on the minds of oil traders is a bit further in the future. When production is ramped up to meet demand in unusual times it must necessarily come from somewhere else. For instance, Saudi Arabia keeps a spare capacity of oil aside as a buffer to avoid disruptions to supply in emergencies.
Unfortunately there is no guarantee that this buffer is large enough to replace Iranian supply in the long term as well as deal with any other market shocks which occur. It might be a case of one or the other, and that makes oil traders jittery. It has been estimated that the available spare capacity currently stands at 1% of world demand, meaning that we may have a big problem if the USA unilaterally manages to push Iranian oil production to anything close to zero.
And it’s not just Iran that might be an issue; other unstable markets such as Venezuela, Nigeria and Libya could also play their part in unhinging the global oil market in the future.
For now things are stable, but it is worth keeping an eye on not just current oil production but also on the global political situation. As the USA is currently proving, ill thought through moves from one superpower could potentially have damaging effects for everybody else down the line, and nowhere is that more apparent than in the world of oil.