Macro Intelligence: why 2023's geopolitical events aren't shaking oil markets... yet

Article by Danielle Ecuyer (ausbiz)

Echoes of the past

Markets climb a wall of worry, as the saying goes, and 2023 is proving to be yet another 'brick in the wall,' if you'll pardon the pun. The Hamas incursion into Israel, coinciding with the 50-year anniversary of the Yom Kippur War in 1973, has left some economic historians puzzled.

"History doesn't repeat itself, but it often rhymes," is the catchphrase, and markets construct narratives to explain price movements. The 1970s were marked by high inflation and an oil supply crisis when Arab OPEC members imposed an embargo on the US for supplying weapons and support to Israel during the Yom Kippur War.

Parallels and divergences: Russia vs. Israel-Hamas conflicts

It's not difficult to draw parallels between that period and the recent events in Northern Gaza. Yet, thus far, the oil market remains remarkably sanguine. Unlike the Russian invasion of Ukraine, which caused oil prices to spike by US$20 per barrel, the current conflict has been less disruptive.

Russia produces 12% of the global oil supply, and the ensuing US-led export embargoes had a significant initial impact on supply forecasts and, consequently, oil prices.

Emerging risks: the role of Iran

To date, the impacts of the Israel-Hamas conflict have been negligible, as neither party is an oil producer. However, the potential for escalation involving other parties, notably Iran, remains uncertain.

Iran, a supporter of Hamas and Hezbollah in Lebanon, is also an oil producer. Challenger's Chief Economist, Dr Keane, noted in a recent report that any reinstated US sanctions on Iran would likely have a muted impact on oil prices. Iran has only recently added 1.5 million bbl/day to supply and accounts for 4% of global output.

The Saudi capacity and the Strait of Hormuz

According to Dr Pearce, Saudi Arabia has a spare capacity of 3 million barrels per day, while the United Arab Emirates and Iraq can offer up to 1 million barrels per day. This capacity could potentially offset any re-imposed sanctions on Iran.

There are still risks, particularly if the conflict escalates to involve other Arab OPEC members. This could restrict the 17 million barrels per day of crude oil and refined products that pass through the Strait of Hormuz.

The US Strategic Petroleum Reserve (SPR), established in the 1970s, serves as a safeguard against supply disruptions. The SPR's holdings were reduced between 2017 and 2021 but halted once prices dipped below US$80/barrel.

Geopolitical risk index: measuring market sentiment

For now the market is relatively calm and is not pricing in an escalation. However, for further insights there is the “Geopolitical Risk Index”, which is compiled by Fed economists and measures the occurrence of geopolitical events/threats/conflicts since 1985 by counting keywords in the media. Investors are very sensitive to ‘If it bleeds, it leads’ headlines.

The chart below provides some scope to the current geopolitical risks with an historical context.

Navigating volatility: IEA's warning and geopolitical dilemma

Looking beyond the geopolitical risks, there are many uncertainties and macro drivers in the energy market. The latest report from the International Energy Agency (IEA) serves as a stark reminder that the supply-demand dynamics in the energy market remain volatile.

The agency describes fossil fuel consumption as too high for governments to achieve their 1.5-degree warming pledges. The IEA forecasts that oil demand could decline by 50% to 55 million bbl/day by 2050.

Interestingly, the IEA was established in 1973 in response to energy insecurity arising from the Yom Kippur War. Now, with the presence of two potentially oil-sensitive conflicts, the prudent strategy would be to secure energy independence through alternative solutions. China's dominance in the critical minerals market serves as a case in point.

Billion-dollar acquisitions and future projections

Amidst this backdrop of uncertainty, corporate activity in the global energy sector has intensified, most notably with Chevron's acquisition of Hess for US$53 billion and Exxon Mobil's purchase of Pioneer Natural Resources for US$60 billion.

Analysts speculate that much of this consolidation is driven by the expectation that oil demand will continue to grow. OPEC forecasts global demand to increase by 15% to 116 million bbl/day by 2045. However, the wave of consolidation may also signal limited access to new supplies, particularly via the development of new greenfield sites.

ETF exposure

For the time being, the primary drivers of oil prices are demand and potential supply constraints. Saudi Arabia has an interest in maintaining higher oil prices, hence the export restrictions implemented earlier this year. However, they are also cautious of demand destruction if prices soar above US$100 per barrel.

Currently, investors appear relatively unperturbed, although headwinds from rising interest rates could exert downward pressure on energy stocks, as indicated by the chart below.

SPDR Fund technical analysis

Those who are seeking exposure without the stock-picking risk might consider the Energy Select Sector SPDR Fund, with the ticker code XLE, trading on the Nasdaq. This fund offers exposure to both global oil producers and major ancillary service companies.

SPDR Fund daily chart