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It’s coming up to two months since hostilities broke out in Iran.
Each day, the news cycle has focused on oil and whether the Strait of Hormuz will be opened. The simple premise is that if the war ends and the Strait reopens, oil prices will drop and the global economy will return to normal.
But while that might seem logical at first glance, markets aren’t always driven by logic.
It also overlooks some of the structural issues in the global oil supply chain and how vulnerable it remains to disruption. Meaning that even if the war were to end tomorrow, uncertainty around oil will remain.
So, let’s take a deeper look at some of those issues…
One of the clear impacts of the conflict is the damage to oil and gas production facilities across the region.
When Iran was attacked, it responded by firing missiles into neighbouring Gulf states. Yet it’s still unknown just what percentage has been damaged, and if and when much of that will come back into production.
Right now, that’s a major variable floating up in the air…
What we do know is that some of it will take years to fix. So even if the Strait were to reopen with guaranteed safe passage, that supply won’t immediately return.
But here’s the thing. There’s no guarantee that the Strait will be opened or remain safe, irrespective of whether a permanent ceasefire is agreed.
And even the U.S. Navy is now saying that it could take six months to clear the sea mines in the Strait, which means shipping rates and insurance premiums for those shipping companies (and their cargo) will stay through the roof… if they can get any insurance at all.
Even if production ramps up, the supply chain is still going to remain under intense pressure. And that has ramifications for the global economy and markets.
For now, though, markets remain on a tear…
As of yesterday’s close, the Nasdaq is up 7.9% since the war began and a whopping 17.9% from its March low. The price action is nothing short of extraordinary.
The bulls might be back in charge of the market right now, but they’re clearly ignoring the risks…
Oil has again been ratcheting higher this past week, even though President Trump extended the ceasefire. Yesterday, Brent crude briefly traded through $100 again before closing around $98. And West Texas Intermediate (WTI) hit an intra-day high just under $96.
We still don’t know who’s actually in control of Iran. Nor if they have any intention of attending any peace talks. Despite the massive damage Iran has absorbed, it doesn’t seem in any hurry to bring things to an end – it looks to be playing the long game.
But if hostilities break out again, you can be sure oil will trade much higher. And even if peace suddenly breaks out, that uncertainty will remain. That’s going to keep a floor under the oil price.
That’s why, for now, any pullback in oil is likely to be limited. Until the market has real confidence that supply routes are secure and production is back to normal, that war premium is going to remain.
For now, markets are ignoring these risks as stocks again head skywards. However, oil prices can’t possibly remain around current levels without eventually putting the economy into recession.
And when that reality begins to bite, markets will be forced to drastically reprice risk – something it has so far chosen to ignore.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
Reading Trading With Larry Benedict will allow you to take a look into the mind of one of the market’s greatest traders. You’ll be able to recognize and take advantage of trends in the market in no time.
