The reaction to the killing of Iranian Major General Qassim Suleimani, the commander of Iran’s Revolutionary Guards Corps, across oil, energy and financial markets has been muted. For now, investors are focused on the supply component of the global oil equation.
American shale oil production has changed significantly in just the past four years, increasing to 9.2 million barrels per day from 5.2 million at the end of 2016. This is part of an increase of approximately 40% in U.S. oil production overall since late 2014.
One undeniable change in the U.S. economy over that span is that higher oil prices today tend to spur greater capital expenditures in the energy patch, bolstering domestic economic activity to offset the negative impact of rising gasoline prices.
Economic risks to the U.S. economy, at least in the early stages of any escalation of geopolitical risk in the Middle East, are, for now, contained. But rising shipping and input costs will hurt the major oil-importing economies across the Far East and Europe. In some respects, any economic risks linked to the military action taken by Washington have been redistributed to the major oil-importing economies.
As a result, we do not expect any action by the Federal Reserve. There would need to be a much greater disruption to oil supply from the Persian Gulf to warrant a rate cut by the Fed in the near term.
Global oil production stands at close to 100 million barrels per day, with U.S. domestic production near 13 million barrels per day. On a global basis, for each increase of $5 per barrel in the price of oil, one should interpret this as a 0.1% drag on overall GDP, or a loss function of $180 billion from the global economy. Given the changing oil supply dynamics, this is the primary reason why energy and commodity markets have been well behaved in the early hours following the airstrike.
In the hours after the U.S. action in Baghdad, the price of Brent crude, the global benchmark for oil, increased as much as 4.33%, while West Texas Intermediate increased 4.38% before falling back in pre-market action in New York. The yield on the U.S. 10-year Treasury slid to 1.81% from 1.87% just before the U.S. market open, while the Japanese yen and the price of gold all benefited from modest safe haven moves in the aftermath of the attack.
In some respects, this is analogous to the pricing movements following the Iranian attack on Saudi Oil facilities at Abqaiq, which temporarily disrupted about 50% of Saudi production in September 2019. In the aftermath of the attack, Brent crude jumped 14.68% in the next 72 hours and then declined 16.61% over the following two weeks as investors stepped back and reassessed the global supply and demand equation within the context of geopolitical risks.
We think that the reaction across asset markets in the hours following the U.S. action does not yet point to any significant disruption of asset prices in the near term. But given the uncertain nature of the interaction between Washington and Tehran, prudence would dictate a general risk-off stance among investors. Given the penchant for asymmetrical responses by the Iranians, the prudent course for firms of all sizes would be to take a look at the hardening of cybersecurity assets.