Time to freak out about oil prices?
President Donald Trump's decision to take the U.S. out of the Iran nuclear deal is hitting investors (and gasoline-buying Americans) where it hurts -- the oil market. That's because the U.S. will reimpose sanctions on Iran's economy and its oil exports.
Crude oil has zoomed above $71 a barrel, returning to levels not seen since late 2014 and pushing up pump prices. Along the way, traders' stomachs were churned by some nasty whipsaw action heading into the announcement. But with the deed now done, what lies ahead, and what are the risks to the economy and stocks?
Inflationary pressure was already becoming a problem: On a year-over-year basis, the headline personal consumption expenditures (PCE) price index has pushed above 2 percent for the first time since 2012. Excluding goods and energy, the measure is at 1.9 percent -- within a hair of the Federal Reserve's inflation target.
Thanks to OPEC's efforts to normalize the crude oil market in the wake of the 2014 price war, crude oil prices have nearly tripled from their early 2016 low and are up 22 percent just since February. The national average price for a gallon of regular gas has increased to $2.77, up from $2.18 last summer and back to levels last seen in the middle of 2015.
According to Credit Suisse, the last time Iran was subject to international sanctions (between 2010 and 2016) its oil exports fell from 2.2 million barrels per day to around 1.1 million barrels. The result was a 15 percent spike in oil prices.
Since the Iran nuclear deal came into effect, Iranian oil output increased from 2.7 million to 3.8 million barrels per day. But demand has also risen during this time, driving oil inventories down to 2014 levels again. Americans have fully embraced SUVs and pickups, with Ford looking at phasing out nearly all of its passenger car models.
Yet the team at Capital Economics doesn't believe Mr. Trump's withdrawal will be a big deal for oil prices in the end. For one, Tehran may decide to stay within the confines of the deal and not jump-start its nuclear program just yet -- hoping to create distance between Washington and its European allies.
Critically, if the Europeans support this, they're unlikely to reimpose sanctions on shipping insurance, which would be key in supporting Iran's ongoing oil exports. Mr. Trump's threat of secondary sanctions on importers of Iranian oil could be undermined by European efforts to shield firms from these impacts, in Capital Economics' view.
Second, OPEC countries have plenty of spare capacity to offset reductions in supply from Iran. Saudi Arabia has voiced political support for President Trump's decision, and it would likely back this up with an increase in output to reduce the negative impact of higher energy prices on American consumers and the U.S. economy.
Riyadh has already pledged to limit any disruption to supply. And OPEC has cut output by 1.6 million barrels per day since the end of 2016, with half of that coming from Saudi Arabia.
And finally, higher prices will encourage more non-OPEC production, especially from U.S. shale producers that have capped productive but higher-cost wells. That has kept U.S. output well off its prior highs.
Overall, Capital Economics is looking for oil prices to decline slightly to $65 a barrel by year-end. That should still be a boon to oil exploration and production stocks. Credit Suisse estimates investors are assuming oil prices near $52 a barrel given current valuations, and it noted that the oil market looks tight, even if Iranian exports aren't affected.