President Trump has withdrawn from the 2015 Iran nuclear agreement and re-imposed economic and sanctions that will impose restrictions on the country’s oil exports. As a result, both Brent Crude and West Texas Intermediate were near their highest levels not seen since late 2014.
Despite the U.S exiting the 2015 accord, it is not clear just how the sanctions will impact given that other signatories have not supported President Trump’s decision. Clarification will be required on whether the sanctions will be applicable to only Iranian companies or non-Iranian companies. Other than oil sensitive sectors (airlines, oil companies…etc.), the strong US dollar, U.S-China trade tensions and Korean peninsula issues has more relative importance given the uncertainty clouding the Asian markets. Once there is greater clarity, we expect Asian markets to increase.
Iran isn’t the only threat to the oil market
Iran is OPEC’s third largest producer and countries that have not significantly reduced their oil purchases from will be penalised as global supply will be less leading to higher oil prices and increased volatility over the coming months. China and India are among a handful of nations that continue to support the 2015 deal. Both are the largest buyers of Iranian oil and along with Turkey, these countries could increase purchases of Iranian oil in return for discounted prices.
OPEC is scheduled to meet on June 22 and Saudi Arabia could raise production to offset market tightness. However, continued political and economic turmoil in Venezuela has seen output fall almost 40% since 2015 and will further decrease global oil supplies putting upward pressure on prices. We expect to see global oil supplies to increase towards the end of this year as refineries in Texas are expected to be turned back on after being damaged by hurricane Harvey last year.
While it was widely anticipated that President Trump would pull out of the Iran agreement, we expect the rise in oil prices will be somewhat modest based on what happened to the price of aluminum in the space of two weeks after the U.S. imposed sanctions on Russian output and announced higher tariffs on steel. Initially, aluminum surged almost 37% before dropping 22% after the U.S. eased restrictions and granted exemptions for its allies.
More Significant Economic Issues
As mentioned above, the strong U.S. Dollar is one of the more significant issues as it has climbed against all of its 31 major counterparts in the past month. Although there continues to be a risk of higher oil prices based on supply constraints and tariffs, leading to higher petrol prices in the U.S., resulting in higher inflationary expectations that has already risen to the Federal Reserve 2% target; this may quicken the pace of interest rate rises thereby making equity markets vulnerable.
Overall, although geopolitical tensions remain high with the risk of further escalation of Middle East tensions that could place upward pressure on oil prices, we believe global equities will continue to increase supported by stronger global economic and earnings growth. We see the Federal Reserve increasing rates gradually by no more than 25 basis points per quarter with a year-end target of 2.5%. We continue to invest more in 10-year U.S. Treasury Bonds over cash.