Financial Times

Geopolitics and geoeconomics are pounding down on the oil market, and the price seems to have no place to hide. The latest barrage comes this week from the re-entry of sanctioned Iranian oil to the world market, triggered by Tehran’s compliance with the nuclear agreement. The lifting of sanctions, originally expected to happen in March or April, was sped up to bolster support for President Rouhani in Iran’s upcoming parliamentary elections. As a result, the returning oil will arrive in an already glutted market at a time of maximum seasonal weakness — and when geoeconomic pressures are mounting.

Oil prices are within hailing distance of where they were at the end of 2003, before China’s economic take-off ignited the so-called commodity “supercycle”, which drove up the prices of oil and other commodities. But the China of 10 per cent annual growth is no more. The question that now haunts the oil market is whether what we are seeing is China’s transition from an industrial to a consumer and services-oriented economy, or whether there are deeper structural problems that mean slower growth and more turbulence of the kind recently seen in the Chinese stock market. The significance for the global economy is enormous, and a weaker world economy means less growth in demand for oil at a time when world supplies are swelling.

The stronger dollar is also buffeting the oil price. A decade ago, when the price was surging and the dollar (in which oil prices are denominated) was weakening, economists talked about how oil moves “co-negatively” with the dollar exchange rate — when the dollar goes down oil prices go up. The opposite is happening today. The oil price collapses in 1986 and 1998 ended when oil exporters got together and reined in production. But geopolitics is working against a quick settlement this time. Saudi Arabia and the other Gulf countries believe that Iran is seeking to become the dominant power in the Middle East. The nuclear agreement not only provides Iran with billions of dollars that had been sitting in international banks because of sanctions, but also enhances Iran’s political position.

The Gulf countries fear this could be further augmented if it leads to some kind of US-Iranian detente. The Ayatollah Ali Khamenei, Iran’s supreme leader, says nothing like that will ever happen. But in the face of a resurgent Iran, the last thing that the Gulf countries want to do is cut back their own oil production in order to surrender space for additional Iranian exports into Asia and northwestern Europe.

Today’s weak oil prices are having a devastating impact on the global energy industry and are putting enormous stress on oil-exporting countries, and on some regions in the US, Canada, Scotland and elsewhere. Worldwide, projects are being slowed, postponed or cancelled, which will begin to affect availability of supplies two or three years from now. IHS projections show a $1.8tn reduction between 2015 and 2020. Skilled professionals are leaving the industry and many will never return.

This steady stream of negative developments only reinforces the sentiment that is weighing down on the oil price. One can add to this the fear among some that the global industry could run out of places to store the surplus.

What could reverse the collapse? Later this year, or in 2017, the workings of supply and demand are likely to start to bring the market back into balance. But there will be a great deal of wrenching anguish between now and then. Alternatively, the impact of the price collapse could be so devastating that exporting countries that have said they will not restrain production — including Russia and even Iran — could change their position and come to terms with the Gulf countries, who insist that they will not cut by themselves.

Then there is American shale oil. US oil output is down about half a million barrels from last April — not as much as was expected last year, partly because new offshore supplies from the Gulf of Mexico are offsetting the decline in shale. However, further declines in US shale would certainly serve to mitigate the widespread market pessimism.

Ironically, another counterweight to that pessimism could come from the fact that sanctions have been lifted on Iranian oil. The agreement of the nuclear deal removes a big uncertainty that has been hanging over the market. Now the question is exactly how much additional oil the Iranians will — or can — bring back to the market. Iran’s finance minister has described the current oil price as representing “an all-out war” for market share. But if the actual volumes turn out to be lower than has been anticipated, or if the Iranians are slower in bringing them back, then the market would have further reason to moderate its bleak outlook. The direction of the oil price and, to a considerable degree, the future of highly volatile global financial markets hang on the outcome.