Oil losing its geopolitical lustre as markets shrug off Iran conflict
I left off 2019 with a column predicting that 2020 would turn out to be pretty boring, from an investor’s perspective at least. And then, just a scant few days into the new year, along comes Donald Trump to throw a wrench into the gears.
On Jan. 3, the predictably unpredictable President green-lighted the assassination of Qassem Soleimani — leader of Iran’s Quds Force and the architect of its programs of regional adventurism and international terrorism — just minutes after the Iranian major-general stepped off a civilian airplane in Baghdad.
However justified by its target’s brutal record, the surprise drone strike on Soleimani and the seemingly inevitable retaliation from Iran — which came on Jan. 8 (local time) in the form of missile attacks on two U.S.-occupied bases in Iraq — looked very much like they could upset the smooth-riding apple cart markets had been on to close the year. In the wake of both events, oil prices spiked. Global stock markets reeled. Gold shot up. Bond yields fell. All were signs that investors feared the implications of an escalation in Iran-U.S. tensions. How far would Iran’s retaliation go? How at-risk are global oil supply lines? What would be the economic fallout of an Iran-U.S. war? Could such a war, or even a tit-for-tat series of responses, lead to a wider regional conflict — or maybe a global one, if, say, Russia or China decided to get involved?
Well, we might not have full answers to all those questions yet, but here’s a working hypothesis: Reports of a Third World War have been greatly exaggerated. And so have worries about collateral damage to investors.
In fact, the market’s recent risk-off moods haven’t lasted very long. On Monday, gold and oil and bonds trimmed their gains from Friday, while stocks gained and the S&P 500 ended down less than one per cent from its Jan. 3 mark. On Jan. 8, markets shrugged off overnight jitters and the S&P 500 reached a new record; gold gave back its gains, and benchmark WTI crude ended up below US$60 a barrel. That’s after it became clear that nobody died in the Iranian missile attacks — which is a sign of either military incompetence or of an intention to signal retaliation without actually doing it. Also on Wednesday, Trump retaliated against the attack by hitting Iran with more sanctions, not bombs. In an address to the nation, he told Americans that “Iran appears to be standing down.”
Well, we will see about that. Iran has its tentacles across the Mideast, and even if it refrains from overt action against American forces or civilians, it could leverage its proxies in Syria, Iraq, Lebanon and elsewhere to hit back over the long term. But it might not. One reason might be that the Iranians see in the Soleimani assassination an opportunity to a) portray itself as the wounded party and b) be seen as taking the “high road” by projecting restraint, both with a view to bolstering its international and regional influence.
Every war is different, obviously, but the world is different now, too.
There might be more practical constraints on Iran, as well. Although the Quds Force no doubt has redundancy built into its leadership structure, Soleimani was reportedly the main point of contact with proxy forces in the region; retaliation through them might not be a turnkey option. As well, Soleimani’s death must have sent a pretty clear signal to Iran’s intelligence and security establishment that something is very wrong if the country’s most powerful military commander can be so easily tracked and taken out; they might want to spend some time getting their own house in order. And whatever you think of the wisdom or legality or rashness of Trump’s decision to carry out an assassination of a foreign government official on third-party soil, it might raise some yellow flags in Iran. In the months before his killing, Soleimani appears to have been increasingly brash in his actions, including a drone strike against Saudi oil facilities last September that U.S. officials ascribed to Iran. Perhaps his death will serve as a caution against similarly high-profile risks.
Of course, this is speculation. Iran might not make good on its pledges of restraint, and Trump will do what Trump will do. But even if there’s an overt conflict and, say, American forces invade Iran, the impact on investors might not be as great as some fear. Markets rallied through the short-lived Gulf War of 1990-1991 and again through the early years of the Iraq War.
Every war is different, obviously, but the world is different now, too. If there’s a growing conflict in the Mideast, the risk to oil supply and delivery is obviously the first issue on investors’ minds. But the fact is, oil is not as important to markets or to western economies as it used to be. For instance, U.S. oil consumption is about where it was 15 years ago, but U.S. GDP has grown by more than 60 per cent over the same period (and that’s including the Great Recession). Meanwhile, with the growth and flexibility of non-OPEC producers in just the past decade, conflict in the Mideast might not be the threat to global oil supply nor the price-booster that it used to be.
For now, markets are pricing in de-escalation of the Iran-U.S. conflict. Maybe they are being overly optimistic, but it looks like the first black swan event of 2020 could turn out to be just an ugly duckling.