Geopolitical risk has helped push oil prices toward $70 a barrel, but the possibility of supply disruptions arising from political or security issues around the world is still not fully appreciated. A close look at the world’s largest oil-producing countries – outside of the United States – shows geopolitical risks mounting and the potential for serious supply reductions if these pots boil over. Venezuela’s meltdown is the most obvious example and is already priced into oil markets, but political hazards are rising in many OPEC nations, even within the cartel’s de facto leader, Saudi Arabia. The full extent of geopolitical risk, whether it be in the Middle East, South America or North Korea, may not be factored into today’s oil price. This points to more upside for a market that has tightened significantly over the past 15 months under the OPEC-led 1.8 million barrels a day (b/d) cut agreement that runs through the end of the year.
It’s never a picnic in the Middle East, but lately, things are looking dicier than usual. In late March Saudi Arabia was targeted by another barrage of missiles fired by Houthi rebels in Yemen. Although Saudi Arabia shot down the missiles, the attack resulted in the first fatality in the kingdom from its three-year war with Yemen’s Houthis, which Riyadh claims are backed by its arch-rival, Shiite Iran. Oil markets shrugged at the news, but if future attacks target Saudi Aramco oil facilities or the Eastern Province, the main oil-producing region in the kingdom, the reaction is not likely to be so muted. Indeed, the long-standing Saudi-Iran battle for regional hegemony deserves special attention these days, with the two involved in proxy conflicts in Syria and Iraq, in addition to Yemen. Tensions are so high that foreign policy experts are starting to seriously ask what a Saudi-Iran war might look like, and whether a nuclear arms race has already begun in the region.
Iran has other problems, too. With U.S. President Donald Trump adding more Iran hawks to his national security team, it looks probable that in May he will pull the United States out of its nuclear deal with Tehran. Washington will likely struggle to find allies in Europe and Asia to re-impose strong sanctions on Iran’s oil exports that existed before the 2015 nuclear deal was struck, making the short-term impact limited in oil markets. However, Iran had big post-sanctions plans for its oil sector, which would be difficult to realize if a hawkish Trump administration enforces existing unilateral U.S. sanctions to the fullest extent. Iran seeks to boost its oil production capacity from roughly 3.8 million b/d to 4.7 million b/d by 2021, an endeavor that will require some $130 billion in upstream investments. It desperately seeks Western technology and investment to achieve its goal, but so far only one Western major, France’s Total, has signed a development contract with Tehran, as sanctions fears pervade Big Oil boardrooms.
A year ago oil traders feared that rising output in Libya would help offset some of the impacts of the OPEC deal, as the North African country was exempted from the agreement because of its security issues. This status gave Libya a certain wild-card status within the cartel. In January OPEC asked Tripoli not to let production exceed 1 million b/d. But few are worried about Libyan production capacity these days and, in fact, its output looks more likely to decline in the future due to years of underinvestment, infrastructure issues, and continued civil strife. Its largest oil fields continue to suffer lengthy shutdowns due to protests, work stoppages and militias blockading essential facilities.
Outside of OPEC, there is the North Korea issue festering still. Military action around North Korea could halt the flow of crude imports to South Korea, Japan and China, which together account for 34 percent of seaborne oil trade globally, according to consultancy Wood Mackenzie, which says global oil markets would be “severely affected” in the event of a regional conflict.
Meanwhile, Russia’s relations with the West continue to deteriorate. Russian President Vladimir Putin’s recent election victory – which gives him a fourth six-year term – means that sanctions pressure on Moscow is unlikely to ease anytime soon. The Kremlin puts on a brave face, but energy sanctions hurt. The Skolkovo energy center at the Moscow School of Management reckons that existing sanctions will result in a reduction in Russian oil production to 10.8 million b/d by 2025 and 9.6 million b/d by 2030 from 11 million b/d in 2017. If sanctions are expanded, the decline is worse — 10.1 million b/d by 2025 and 8.53 million b/d by 2030.
This is why the U.S. oil industry cannot take its foot off the gas pedal. It must avoid complacency and remain on its rapid growth trajectory. Geopolitical volatility is intense, and potential supply disruptions loom on many fronts. The US must be ready to fill any voids, both to ensure its energy security and capitalize on the economic opportunity at hand. Because at the moment, America looks like one of the few safe bets oil investors have on the geopolitical risk spectrum.