Investors Unphased While Iran Stays Out of Israeli-Hamas War

In 2019 when President Trump pulled out of the 2015 Iran Nuclear Accord and reimposed Oil sanctions, Iranian Oil production plummeted 50% to less than 2 million barrels a day (mbd). For two years Iran’s Revolutionary Guard and Mullahs were starved of vital revenue for which to foment war and arm their proxy armies in the region to carry out their threats. When President Biden became President in 2021, he quickly withdrew sanctions and allowed Iran’s production to jump 50% within a few months. Today Iran is producing about 3.3 mbd and exporting over 2 mbd of which the majority secretly ends up in China. Should Iran reach its 2024 goal of 4 mbd it would equate to $125 billion at todays $86/barrel Oil or a third of their entire GDP. This backdrop is helpful in understanding the ability of Iran to arm Israels’ enemies in Gaza, Lebanon Yemen, and Syria and risk a proxy war with the Jewish state. It would be surprising should Iran “directly” enter the Israeli – Hamas war and risk losing all of their Oil production and nuclear weapons facilities that are critical to their dominance in the Middle East. However, there is a modest risk that Israel will feel threatened enough to strike Iran first, against the wishes of the US. The highest odds over the next month of this conflict are that Iran’s proxy armies will enter the fray as soon as Israeli ground troops invade Gaza to root out Hamas. Time is not on Israel’s side as Western allies in Europe will become increasingly critical of the almost certain humanitarian crisis that is just beginning. If war ever spreads to the Iranian homeland, global Oil prices will easily spike above $100/barrel since there is not enough spare global capacity to replace a shutdown of Iranian production. While this is currently a relatively remote outcome, the escalating war rhetoric and expected spike in missile attacks upon Israel will add an Oil fear premium to an already tight global supply chain.

Normally the US would be a swing producer to buffer shortfalls had this Administration not drained the Strategic Petroleum Reserve (SPR) down to 4-decade lows and held back pipeline and supply chain growth over the last few years. A low SPR and lean inventory stockpile from current production will keep the US from taking advantage of exogenous events to buffer global supply shortfalls.

Despite the anti-Oil industry legislation, US production finally returned to record levels last month at over 13.2 mbd. The US leads the world in Oil and Natural Gas, even without sufficient pipelines and ports to handle our kinetic production capacity. Should the worst-case scenario occur that curtails Persian Gulf and Iranian shipments abroad, only the Saudis are able to quickly add 2 to 3 mbd to calm markets after a spike above $100/barrel. It would be wise for the current Administration to renew our decades old alliance with Saudi Arabia as a Persian counterweight.

In September we advised staying away from red hot energy sector investments due to slowing fuel consumption and the expected winter seasonality. Our forecast targeted a final peak in the mid to upper $90’s/barrel in September to early October. Energy stocks (XLE) peaked on September 14th and the underlying Oil price topped out at $95 on the 27th. After the recent 15% correction and technical oversold reading basis RSI and Stochastics, there is room for a rebound short term with the fear premium over Mideast war as the primary catalyst. Our forecast remains for slowing fuel consumption in Q4, a US inventory build and seasonal winter weakness into Q1 of 2024. However, there appears to be a well-planned chess game by Iran to draw Israel into an expanding war with a growing list of proxy armies taking part. Until the war premium reaches a climax, there should be a floor under Oil prices in the $80’s/barrel with fear factor upside risk of the low to mid $90’s in coming weeks. While a fight that spreads to Iran proper would trigger a major energy price spike ($108+), the odds remain low at this juncture. Oil prices should fall back under $80 once the war escalation phase begins to reverse. Over the short-term, energy stocks are a safe place to park a minority capital position for traders, but with risk free 6% CD’s, energy remains a speculative sector over the winter months.

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