Takeaway: Oil markets should prepare for spikes of geopolitical risk this summer with Iran drone and tanker attacks & US responses

Geopolitical Risk: Iran’s answer to US Maximum Pressure is Maximum Chaos; OPEC Sets Meeting Dates - IMG 3841

Click here for the video of a discussion on Iran’s maximum chaos strategy and an OPEC meeting preview with Hedgeye’s energy policy analyst Joe McMonigle and chief political strategist JT Taylor.

Iran shot down a US surveillance drone flying in the Strait of Hormuz Thursday moving the US-Iran confrontation in the heart of Gulf oil production and transport into a new phase. 

President Trump is meeting with his national security team to discuss the US response.  

While some commentators still debate whether Iran was behind the two tanker attacks in less than a month, Iran is making its intentions clear.

If the US has a maximum pressure policy, Iran is now implementing a maximum chaos plan with the objective that higher oil prices and threat of military conflict make the US and Trump rethink its policy. Specifically, Iran believes higher oil prices will hurt Trump politically and may impact his decisions on increasing the pressure or even perhaps to revisit waivers.  

We think Iran is misjudging Trump as he views the Iran policy as stand-alone from oil prices. Moreover, as was stated when Iran oil waivers were not renewed, the administration believes that global spare oil capacity and surging US production will mitigate price hikes. 

With shoot-down of the US drone in the Strait of Hormuz, it’s clear Iran is pursuing a new maximum chaos plan to answer the US maximum pressure policy. The start was the tanker attacks and increased drone attacks from Yemen into Saudi Arabia. Next week Iran will breach its commitments in the JCPOA nuclear agreement by exceeding limits on uranium enrichment that will force the Europeans to make decisions on sanctions.  

US sanctions are really started to bite Iran as they see their customers fall one-by-one, and we think they want to spread the hurt around. Even Iran’s illicit attempts at oil trade around US sanctions are getting impacted with Wednesday’s report that ENI had rejected a cargo marketed as Iraqi crude that ENI concluded had properties similar to Iranian crude.

We think oil markets should prepare for spikes of geopolitical risk this summer primarily from Iran but also responses from the US and perhaps Saudi Arabia. Geopolitical risk in the heart of the oil producing Gulf and a major crude transport corridor will only rise, and the market will start to see it more and more of it like whack-a-mole.  

The current market focus is on the macro narrative and fears of a slowing global economy but geopolitical risks will be increasing and vying for attention.

OPEC Meeting Now Set for July 1 & 2

Meanwhile, OPEC has finally agreed to a meeting date on July 1 and 2 that is one-week later than its original dates in late June.

In our view, we will not only have a rollover of the meeting date but very likely a rollover of the production cuts that expire on June 30.

The meeting dates drama was just a side show.  The main show is the production policy decision and outcomes. As Saudi Minister Khalid al-Falih said recently the extension is “in the bag.” But we believe there are two open questions: 1) what will be the duration of the cut extension: and 2) will Russia comply.  

Both questions are interrelated. First, it looks like Russia has agreed to the rollover as a result of Saudi minister al-Falih’s trip to Russia ten days ago.  One of the outcomes was an announcement of a Putin trip to Saudi Arabia in October. We doubt this announcement would have happened but for a Russia agreement to a rollover.

Russian energy companies don’t like the production cuts and oppose the extension. But it is also a growing concern of Russian government officials who view surging US production past them as the world’s number one producer as a threat to market share.  

Putin is a wildcard because he likes the world stage that comes with partnering with Saudis on oil market management but he too is beginning to get concerned about US production, impacts of cuts on the Russian economy, and in general the oil dominance race with the US.

On compliance, we believe there is a tacit agreement between the Saudis and Russians that Russia can have a flexible compliance, as we outlined in our oil meeting preview note. The Russian companies want to hike production so while we think Russia agrees in principle to a rollover in a sign of unity, we will have to watch closely Russian compliance in the months ahead.  

On the length of the cut extension, it’s hard to see it going more than 6-months due to Russia’s concerns about the extension.  While certainly a longer extension will be more bullish for prices, we doubt Russia will go along.  Moreover, a six month extension will coincide with OPEC’s winter meeting in early December, when we will see this scenario again.