Oil Market Impacts from Iran

Strikes in Iran have reignited concerns about oil supply, inflation pressure, and cross-asset volatility. How significant are these disruptions, and what are the implications for the global economy? I'm Allison Nathan, and this is Goldman Sachs Exchanges. Today I'm sitting down with my colleague in Goldman Sachs Research, Don Stroyvin, co head of global commodities research and the head of oil research. Don, welcome back to Exchanges. Thank you, Alison.

Down before we turn to markets, we just want to acknowledge first the very real human cost of any escalation in the region. Our focus here today is strictly on the economic and market implications. So with that in mind, Don, the last time we had you on this program, we were talking about Venezuela and the oil market impacts of those developments.

Clearly, we have had the US and Israel launch over the weekend a military campaign against Iran. It has killed Iran's Supreme Leader, Ayatollah Ali Khamaneh. So how significant are these developments? Most importantly, thinking about what is actually happening on the ground in terms of oil infrastructure and supply.

Yeah, so the developments are definitely significant, especially because flows through the Strait of Ormuz, which in normal times accounts for about one fifth of global oil supply, are down very sharply with only some Chinese ships. Reportedly going through the straight. And as a result, I think the rise in oil prices up eight percent since Friday, up twenty five percent year to date. I think that increase is appropriate in light of the rise of duplicate risks to energy supply.

When we think about the actual disruptions we're seeing now, are you actually getting confirmation that oil infrastructure has been disrupted in some of these other countries, either from the port side of things, fields, refineries? Talk us through it. Yeah, so in the oil market the impact is the most significant in terms of export flow.

with a very sharp drop in volumes coming to the Strait of Ormuz, not because the strait is completely shut, but because shippers, oil producers are going to a wait and see mode because they have seen reports of three ships that have been damaged and because insurance premia have skyrocketed. In terms of actual production as opposed to export There are some reports that production in Iraq is down somewhat, around zero point two million barrels per day.

Saudi Arabia's largest refined products refinery is apparently also shut, worth around zero point six million barrels per day. So in the oil market the impact is a lot bigger on flows, on export than on production. But on the natural gas side, the largest LNG export plant in the world from Qatar is shut at the moment. Interesting. And I think that is an interesting point you make, Don, because you think about the street of Hermov's closure. We talk about that a lot.

As you said, right now it in itself is not being shut, but people are voluntarily deciding not to send flows through there because of the risk involved. Absolutely. And we are seeing the broader region actually involved as well in some of these developments. How is that impacting supplies and infrastructure for energy around the region?

I think that's very significant and a major difference with the tensions we saw last summer, with strikes from Iran now also having hit Assets in the GCC, Gulf Corporation Council countries. Such as Saudi Arabia and the UE, there is now a tail risk where you could see not only damage to export flows but potentially also to production, with Saudi Arabia being the largest crude exporter in the world.

And I think the rise in oil prices does reflect some probability that the conflict may last or may extend and broaden.

So if we think about how this all impacts the oil markets over the short to medium term, Don, walk us through the scenarios you're potentially looking at and what is your base case today. Yeah, so our base case assumes no sustained supply disruptions and that's why we have maintained our base case energy price forecast.

But the upside uh to Which are by the way, sorry, clarify for us. Yeah. Our base case is that Brent, which is now currently around seventy eight, will bottom this cycle at sixty by the end of this year in the fourth quarter. assuming no sustained supply disruptions. But clearly the upside risks are very significant.

The upside risk from a sustained closure of the state of Remoose could be very large, and one key point I want to make is that the impact on prices is likely nonlinear, a convex function of how long the supply disruption lasts.

So to put some numbers on this, if you see a hundred percent full closure of the strait for about a month, And if we can use the roughly four million barrels per day of estimated spare pipeline capacity to bypass the strait, our models point to twelve dollars of upside to prices.

Now, if the disruption is significantly shorter than one month, a few days, a week, the impact may be disproportionately smaller because crude could simply be stored on land in those producing countries in the Middle East and the oil would still be delivered

Down the road. So essentially deliveries would be delayed, but no significant effect on cumulative supply available to the global oil market. In contrast, if the conflict lasts if the disruption lasts longer, if you run out of storage facilities, if production has to be shut in. And if the straight-over moves is closed for a very long time, you cannot draw inventories forever. And the market may have to rebalance by incentivizing prices.

to such high levels that you generate demand destruction. And we typically find that in oil markets, to generate substantial demand destruction. prices may have to rise into a triple digit territory. So the length of the disruption to the straight over moves is the single most important variable to watch right now in oil market.

But just to clarify, all those numbers you gave were relative to your base case. That's right. When we think about the eight percent increase in oil prices we've seen over the weekend, what is that pricing in at this point in terms of disruption? We think that the fair value for brand at the moment, assuming no sustained supply disruptions, is around sixty five dollars. With a market price at seventy eight.

The market is essentially pricing in a thirteen dollars per barrel risk premium, which on our models corresponds essentially to the market pricing in a full closure of the Strait of Armouse for around four weeks. If the market were 100% confidence,

that uh straightover moose were to be shut for four weeks, that's essentially where the price would be, as clients can now see on their screen. Of course, in reality, traders need to think about a whole range of scenarios, including shorter disruptions, but also escalation scenarios and longer disruptions.

Right, but the market does price a pretty meaningful disruption at this point, but there's a lot more upside, as you just said. If we were to see the type of disruption that the market is expecting right now, how painful would that be for the global economy?

Could be pretty significant if the disruptions are sustained and large. One rule of thumb for the US and European economy, for instance, is that every ten percent increase in crude oil prices that's sustained raises headline inflation about three tenths of the percentage point and therefore reduces disposable income after adjusting for prices also by around zero point three percent. Now I do think the twenty twenty two experience is an interesting one. Both the US and Europe

avoided a recession, despite very sharp increases in prices, because there were several other tailwinds to the economy, and the underlying fundamentals in the private sector were healthy. Or the base case from our economists This year is not too dissimilar. Healthy consumers, healthy private sector, supportive financial conditions, tax cuts in the US. And so I think it would take a relatively large and sustained increase in energy prices.

to alter that still benign base case into a more adverse outcome for the globalist. Right. We have the benign economic backdrop right now and we have the bonus of spare capacity on the supply side. That was what was driving a lower oil price forecast. That spare capacity is concentrated in the Middle East.

And so as long as the Strait of Vermoose is closed, you cannot really physically deploy that spare capacity because those barrels largely the spare capacity is largely concentrated in Saudi Arabia, the UI and Kuwait. Most of these barrels typically float through the strait. So they're trapped. Whenever we have these type of developments, which thankfully are not very often, we often hear about the strategic petroleum reserve, which

supposedly is here just for this type of scenario where you might have extreme disruption. When does that come into play? Is that something on your mind right now? Yes, I think that if we were to see a sustained supply disruption and significantly higher oil prices, this would be a textbook case to deploy the strategic petroleum reserves, whether it's in the US other developed markets or even China, which has built up a very substantial strategic petroleum reserve over the last few years.

That said, one Department of Energy official did tell the Financial Times over the weekend that at the moment this is not really being discussed at all. It may reflect An anticipation or a base case from DOE officials that the conflict may not be very long-lasting. And the other key point to make is.

The level of the US strategic petroleum reserve is significantly lower than before 2022. We now have around four hundred and fifteen million barrels in the US SPR. That is more than two hundred million barrels lower than before the start of the twenty twenty-two energy crisis. Right. So it's a cushion but not as large of a cushion and right now there's not a lot of talk about using it or needing to use it. But that could be a potential buffer as well to the economy.

When we are also in these type of environments, we start talking again about safe haven assets. Don, I think another recent conversation we've been having is gold. How is gold reacting to this? Are we seeing the safe havens responding? I think the safe havens are performing well today in financial markets, whether it's gold or some of the safe haven currencies like the US dollar. Our highest conviction recommendation continues to be gold, both because of an attractive base case.

where this diversification from central banks into gold continues and then critically we think gold is a very helpful hedge against geopolitical shock. against the institutional macro policy shocks. And then if you combine it with energy, which hedges you against more traditional negative supply shocks, as an investor you're pretty well hedged against deflation shocks that can weigh on the performance of equity bond portfolio.

So what are you watching, Don? A lot of uncertainty as these developments continue. What are you most focused on? So on the oil flow specific side, laser focused on flows to the Strait of Ormuz, what are we hearing from the shippers, from the insurers, what are the satellite data showing us? When can we expect a potential recovery in volumes? And then more broadly, any signals about the potential length of the conflict? Signals that could suggest the conflict could last longer.

Include potential communication from the US administration that the goal of this operation is a broad and ambitious one, such as for instance regime change. In contrast, if the rationale is mostly motivated by more narrow military goals, like reducing missile capacity, reducing nuclear capacity, then that may be a signal that the conflict may be somewhat shorter. Another key thing to watch is

Who will be in charge in Iran? If you were to see a more reformist leader taking charge, that could also be an off-ramp and a route to a less extended conflict. So a lot to watch. Thank you so much for joining us on short notice. Thanks a lot, LSM. Thank you for listening to this episode of Goldman Sachs Extreme. Which was recorded on Monday, March second, twenty twenty six. I'm Alison Nathan.

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