Here’s the real reason oil prices are soaring – it’s not all about Iran

Oil refinery in Iran © Getty Images
Tougher sanctions will make it harder for Iran to produce and export its oil

This article is taken from our FREE daily investment email Money Morning.

Every day, MoneyWeek's executive editor John Stepek and guest contributors explain how current economic and political developments are affecting the markets and your wealth, and give you pointers on how you can profit.

Sign up free here.

The oil price has hit a new high for this year.

Brent crude (the European benchmark) has risen to around $74 a barrel, while WTI (the US equivalent) is around $66.

Why? There’s always a story in the oil market. And this week, it’s all about Iran.

The latest explanation for the rising oil price

The US had already imposed sanctions on Iran, but until this week, it had granted waivers to allow certain countries to continue to import Iranian oil without fear of American disapproval.

That’s no longer the case. The waivers will be removed at the end of the month. After that, countries who continue to import oil from Iran could also face US sanctions.

What kind of effect might that have on the market? Well, during the past five months, notes the FT, Iran has managed to export anything between one million and 1.9 million barrels of oil a day, according to various expert analyses. It’s not Saudi levels, but it is significant.

Most of that oil has gone to India, China, South Korea, Japan and Turkey. China is likely to tell the US to sling its hook and carry on importing, and some or all of the others may well think about doing the same, but there’s no doubt that this will make it harder for Iran to produce and export its oil.

The US says that it has already got this covered – Saudi Arabia and the United Arab Emirates are going to pump more to cover the gap. Given that Saudi Arabia has been holding back on production with the aim of propping up prices, the spare capacity is certainly there.

On the other hand, Iran isn’t the only country where supply is under threat. Venezuela is being hit both by sanctions and by economic collapse (the latter predates the former by the way, regardless of what regime shills try to tell you). And you’ve got Nigeria and Libya, both of which are vulnerable to conflict.

Equally, there’s no guarantee that Saudi Arabia will step up. On the one hand, it will relish the chance to poach its arch-rival’s customers; on the other hand, keeping oil prices high is very tempting too.

Why Donald Trump won’t be happy about rising oil prices

Now, we can see why the US might be keen to keep oil prices down. The average price of petrol in the US is now at its highest since October last year, and as the Financial Times points out, it only needs to rise by another few cents to hit a five-year high. That is not something that Trump will be happy about.

Voters care about the economy. The good news is that, as long as their personal situation seems broadly stable – ie, they have jobs and somewhere to live – they won’t worry too much about the “big picture” anxieties, like the national debt.

However, there are a couple of key measures (which vary from country to country) that – as a rule of thumb – will worry them. And the bad news as a politician is that you have little direct control over them.

In the UK, the two prices that people care about are house prices and petrol prices. One is a measure of personal wealth and the other is a measure of how much pressure is on your income.

For the US, the wealth measure is different – voters care about the level of the S&P 500 rather than house prices. That’s because more Americans have money in the stockmarket, or aspire to.

(Incidentally, this is why the central bank and government in the US act to prop up the stockmarket; whereas in the UK, the central bank and the government act to prop up the housing market.)

But as far as income goes, the measure in the US is the same – people care about how much it costs to fill up their cars. And in the US, it’s a much bigger deal when the oil price rises. That’s because tax on petrol in the US is relatively low, so any rise in the oil price results in a much bigger move in the price at the pump.

Given that there’s an election coming up in 2020, Trump won’t want record high oil prices and therefore high petrol prices rattling the voters. It doesn’t help that voters in pro-Trump states tend to spend more of their income on petrol.

Trump can’t suppress the oil price – and nor can anyone else

But can he do much to prevent this? Absolutely not. Beyond the occasional strategic “release” from America’s oil emergency reserves, there’s not a lot any president can do to manipulate the oil price.

That said, the ability of oil cartel Opec to fiddle with oil prices is also over-exaggerated. The reality is – as I’ve pointed out before – that moves in oil prices are often as much a function of the market’s risk appetite as a result of moves in the balance of supply and demand.

Put simply, when the market is in “risk-on” mode (which it clearly is now, what with Larry Fink at BlackRock talking about a pending stockmarket “melt-up”), the oil price tends to go up.

And given that the melt-up probably won’t end until it reaches a point where the exuberance exhausts itself (or fear of inflation and rising Federal Reserve interest rates returns), I suspect that the path of least resistance for oil will be higher.

I wouldn’t bet on the oil price directly (too many ups and downs; too much hassle). But if you’re hanging on to oil producers in the face of all this “sustainable investment” talk, keep hanging in there. They have a while to go before they’re obsolete.

And do subscribe to MoneyWeek magazine if you haven’t already – what with all of this talk of a “melt-up” you might want to have some investment ideas at the ready to take advantage. Get your first six issues free here.