As US and Israeli artillery showers down on Iran, in a bid to force it into curbing its nuclear enrichment program, and the Middle Eastern nation hits backs on strategic Western-allied targets in its vicinity, its status as a top-five oil producer has investors wondering how markets might react to a prolonged conflict.
This article is a journalistic opinion piece which has been written based on independent research. It is intended to inform investors and should not be taken as a recommendation or financial advice.
Iran has also retaliated by blocking off the Strait of Hormuz, the most efficient passage for approximately 20 per cent of the world’s oil supply, which the International Energy Agency expects to reduce global supply by about 8 million barrels per day in March.
This level of oil market shock, not seen since the 1970s Energy Crisis, when OPEC cut oil production in response to US support for Israel during the Yom Kippur War, sent crude near US$120 on Monday, a mark it has since retreated from, settling just under US$100, reflecting the notion that cooler heads will prevail and seaborne supply will eventually return to normal levels.
This thesis has been discussed at the policy level, but has yet to play out on the ground, with strikes continuing on both sides, leading the IEA to institute the release of a record 400 million barrels of oil from strategic member stockpiles to keep the market afloat. That said, the agency is confident in global supply outpacing demand on a year-to-year basis, should affected producers succeed at establishing alternative routes to the Strait of Hormuz.
Nevertheless, Iran intends to continue attacking foreign oil tankers in the Gulf Region, according to Ebrahim Zolfaqari, spokesperson for Iran’s military command, who warned on Wednesday that the United States should “get ready for oil to be US$200 a barrel, because the oil price depends on regional security which you have destabilized.”
Iran’s new Supreme Leader Mojtaba Khamenei followed this up with a national TV address on Thursday, assuring the Iranian people that “we will not neglect avenging the blood of your martyrs.”
US President Trump has been equally defiant, claiming during a rally in Kentucky on Wednesday that the US had already won the war, noting that, “in the first hour, it was over.”
This stalemate sets the stage for ongoing disruptions to the world’s oil supply, encouraging higher prices – which likely won’t reach US$200, barring some global disaster – but will have trickle-down effects across the supply chain, unleashing a cascade of implications for investors in the space.
Here are five worth integrating in your due diligence.
1. Frontier exploration becomes viable
As oil prices edge higher, explorers will benefit from an increasing minimum threshold for profitability for future wells, easing the path to raising capital and developing projects often dismissed as uneconomical. This includes:
- Ultra-deep-water drilling, where wells can run you in excess of US$100 million and rough environmental conditions place a premium on labour and infrastructure.
- Lower-quality oil that requires more work to extract and refine, including bitumen, shale oil and heavy oil. These are highlighted by Canada’s oils sands, where major producers can break even at just over US$40 WTI, and Venezuela’s world-leading reserves, whose hundreds of billions of barrels need US$80 WTI to justify production.
- Enhanced oil recovery, which employs costly CO2 injection to improve oil flow in mature fields, often significantly boosting output in areas that would otherwise be abandoned.
Companies best positioned to unlock value under these circumstances should be able to do so from a position of strength, meaning that available liquidity, internally generated cash flow, certified reserves and jurisdictional safety should be the ultimate determiners of your investment decision.
2. Margin erosion becomes a clear and present danger
If high oil prices point to a bright future for new projects, the prospects for the present moment are considerably more glum because of soaring input costs, with diesel for rigs, the steel they’re made of and the lubricants for their multitude of parts all requiring oil to produce. As oil prices rise, so will demand for the services and equipment required to bring it to market.
This profit squeeze could potentially be offset through renewable energy, as well as pricing power with long-standing suppliers, pointing investors to established, strategically located producers, whose differentiated infrastructure and technology enables them to find value where legacy operators cannot.
3. Demand destruction brings a bear market into view
Should the war between US-Israel and Iran escalate, leading to higher oil prices for longer, industry hardships would eventually spread across the global economy, as the industrial complex that enables modern society cannot function without the burning of fossil fuels. From the 18-wheeler that drove your carton of milk to the grocery store, to the synthetic fiber shirt you picked out for church this Sunday, to the diverse array of plastic products that simplify your life, oil is at their centre.
The collective effect here, a pronounced rise in consumer prices, would bring a recession and a bear market into play, as oil stocks outperform and the rest of investors’ portfolios languish because of falling demand, rising costs and hawkish monetary policy to keep the economy from burning up into a crisp.
4. Renewable energy’s moment in the sun
While untenable oil prices would drain the life out of the economy, they would also expedite the shift away from fossil fuels, serving as a high-signal marketing tool for a more sustainable future.
From a relative value perspective, green energy and electric vehicle projects would instantly become more attractive, both for companies with enough capital to allocate, as well as for investors with enough dry powder to put to work, aligning bottom lines with environmental stewardship for the first time in history.
This dynamic would shine a light on sustainability-focused companies that have managed to garner market share and turn a profit in the face of oil’s supremacy, whose value propositions would only be enhanced by the cataclysm that would be US$200 oil.
5. The great onshoring
Finally, it’s worth noting that a tight oil market will incentivize home-country bias, with producers in stable jurisdictions, including Canada, Brazil and the United States, likely to see a massive increase in demand as businesses reorient away from Middle Eastern supply and governments limit exports to support domestic industries.
Iran’s oil industry would, in turn, descend deeper into shadow market territory, offering discounted product to any country comfortable with skirting sanctions and the free market.
Logically, home-grown operators will be poised to benefit, especially near-term or active producers with generational reserves, protected by an ironclad rule of law, in the hands of proven leadership teams when it comes to efficiently and cost-effectively getting barrels out of the ground.
Takeaway
With US-Israeli strikes carrying on unbated across the capital city of Tehran, and Iran continuing to engage in attacks in Lebanon, Oman and Saudi Arabia, as reported by Al Jazeera, there is no clear sense of when the conflict will end, having displaced millions of citizens across the Middle East since aggressions began on February 28.
For the moment, this means businesses, consumers and investors have good reason to expect higher oil prices over the coming weeks and months and modify their capital allocation strategies accordingly.
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