The FTSE 100’s major oilers were on the rise on Monday as tensions between the US and Iran increased sharply following the assassination of a senior Iranian military commander in a drone strike last Friday.
Shares of the big oil firms were outperforming the smaller fry as their geographical spread gives them an advantage amid the instability as their operations are much less reliant on a singular region such as the Middle East, says SP Angel analyst Sam Wahab.
By contrast, smaller oil firms with their operations concentrated in the area are suffering declines as the potential for conflict puts their production in the firing line.
One example is mid-cap oiler Gulf Keystone Petroleum Ltd (LON:GKP), which slipped 2.9% to 204p as the increased possibility of conflict in Iraq, Iran’s neighbour, could disrupt production at its Shaikan field in the north of the country.
Prices could exceed US$80 a barrel
The killing of Qassem Suleimani, the head of Iran’s powerful Quds special forces, has left many concerned that the political situation in the Middle East could destabilise and potentially disrupt the region’s oil supplies.
A particular flashpoint is the Strait of Hormuz, a key sea lane through which around 25% of the world’s oil is transported.
“Not only are the tensions between the US and Iran destabilising the Middle East, but oil supplies from Iraq are directly under threat”, said Jasper Lawler, head of research at London Capital Group.
On Monday, Brent crude prices spiked briefly above US$70 a barrel before dipping back down to around US$69.5, although this is still its highest level since May last year.
If Iran retaliates against the assassination of Suleimani, most likely against US interests in the Middle East or those of its main regional rival, Saudi Arabia, Wahab says prices of crude could rise further to levels “well in excess” of US$80 per barrel not seen since October 2018.
Iranian missile strikes on Saudi oil facilities last September also show that the threat of military retaliation is high.
“The geopolitical risk has not yet been fully priced in”, Wahab says, adding that while a diplomatic de-escalation of hostilities could be possible, it was highly improbable given rhetoric from both sides in the wake of the killing, particularly Iran’s recent announcement that it will no longer abide by requirements imposed by a 2015 agreement with the West over its nuclear programme.
Global economy could suffer amid oil price shock
While the rising cost of crude could benefit the BPs and Shells of the world, the macro picture is a lot more gloomy as an oil price shock could send reverberations through a global economy, which is already fragile state amid weak manufacturing and slowing consumer demand for goods.
CMC Market’s Michael Hewson says that if crude manages to hit between US$75-80 a barrel it “could derail what in the past few months have been some faltering signs of a rebound in economic activity”.
A steep rise in the price of crude due to geopolitical tensions will also bring echoes of the ‘first oil shock’ in the 1970s when an embargo by Middle Eastern countries against nations perceived to be supporting Israel during the Yom Kippur War caused prices to rocket nearly 400%, causing long-term effects on the global economy.