Paris Tragedy May Shift Oil ETFs

Geopolitical developments often have a major impact on oil prices since they can affect oil supply directly and since the threat of future supply disruptions can also build a risk premium into oil prices. As a notable example, in the early part of 2014, conflicts in Libya and Iraq led to temporary outages in their oil production, keeping world prices high, even as supply elsewhere in the world continued to ramp up. When production from those two countries came back on stream, that was an important trigger for the plunge in oil prices later in the year.  Notice how much oil price spiked at the historical times of war.

While the S&P GSCI Crude Oil only is recorded since 1987, below is a chart that goes back to 1947 by WTRG Economics that shows spikes in oil price jumped more than 2 times on average during critical periods of conflict, including the Iran/Iraq War, Iranian Revolution, Yom Kippur War and Oil Embargo.

War Oil History

Generally, when there is a war, commodities perform well since it takes resources to fight a war and people will continue to drink coffee and eat cereal, which is the kind of fundamental economic diversification that makes this asset class important. For example, below is a graph of the S&P 500® versus the S&P GSCI during the Persian Gulf War that shows while stocks dropped, commodities rose.

Source: S&P Dow Jones Indices

In the recent environment, OPEC is committed to maintaining market share in the global oil markets. Shortly after the natural gas deal was signed between Russia and China, OPEC started flooding the market with oil to drop the price so marginal producers exited. This also happened in the 1986 period when OPEC dropped the price from $32/bbl to $10/bbl which may have led to the breakup of the Soviet Union. The current low oil price has divided the world by importers, exporters, developed and emerging markets

Now, just as the world is agreeing on a chance for structural reform, the picture may change again. The ISIS attack on Paris might be the catalyst to change OPEC’s oil market policy of defending market share. Saudi Arabia may need to alter their focus to support defensive measures rather than maintaining oil market share. There is a pivotal question about whether Saudi protects the long-term value of oil reserves or if they defend their role as the pre-eminent Sunni power in the region… both are important.