Last Thursday, two tankers were struck in an apparent second attack in a month on seaborne oil shipments in the Middle East. Political tension has risen as a result with the US accusing Iran of the attacks and Iran denying any complicity. However, Iran had threatened to block this key oil chokepoint after the US announced abandoning the nuclear deal. The attacks took place just outside of the Strait of Hormuz, which connects the Persian Gulf with the open seas, and through which about 30% of all oil tanker traffic travels.
Upon the news, oil prices initially rose, but have fallen back. As of Friday, West Texas crude sat at $52.50 a barrel, above its price of $45.15 at the end of last year, but well below its price of $66.91 at this time last year. Besides the several tanker attacks, in May there was also a drone attack on a Saudi pipeline. Despite escalating tensions, crude prices are actually down about 20% from their April highs. How can this be so?
Well, there are a lot of variables that go into determining the price of oil, with Middle East tensions being just one, and probably a less important variable than it used to be. That is not to say that any military conflict between the US and Iran will not be an important factor, but as of now the market is seeing the current state of affairs as posturing. Other supply side influences include: OPEC voluntarily cutting output, Russia grappling with the problem of exporting $2.7 billion of contaminated oil (oil piped to Europe, which was heavily contaminated with production boosting compounds that were not removed, but can destroy refining equipment and create chlorine gas), Venezuela under sanctions and in economic collapse, and Libya in civil war with armed militias interrupting oil exports. In addition, increases in US production and exports have changed the global supply equation. In the last three weeks, US oil exports have averaged more than 3 million barrels per day, after only topping that level a handful of times in the past.
However, the demand side of the equation maybe keeping a lid on crude prices. The escalating tensions in US-China trade have increased fear that global growth will weaken. If so, demand for oil will also decline. Signs of slowing growth are already evident. Friday, data showed China’s industrial output growth had unexpectedly slowed to a 17 year low. In addition, export orders in Asia and Europe are markedly muted and global industrial activity remains weak. Although central banks remain accommodative, global growth is expected to slow to 2.6% in 2019.
So, for now, despite the supply-side shocks and escalating tensions in the Middle East, the fear of a global economic slowdown has provided an effective counterweight to further rises in crude prices.
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Rick Cloutier, CFA is the Chief Investment Strategist for Washington Trust Bank with over 25 years of portfolio management and investment experience. He is responsible for directing the portfolio management, research, and trading activities for the bank’s multi-asset class strategies. He is also responsible for overseeing the client portfolio manager team and portfolio analytics team. Rick has written numerous articles for Investopedia and wrote a weekly column for the Fall River Herald News in Massachusetts. His research has appeared in numerous journals, including the Journal of Investment Management and Financial Innovations, the Journal of Business Management and Economics, and the International Journal of Revenue Management. He provided a nightly commentary on WALE radio and authored the novel Caveat Emptor. Rick earned his MBA at Boston University.