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War Risks Rise as Saudis Strike Back; China Demand Grows

05/17/2019 1:26 pm EST

Focus: GLOBAL

Phil Flynn

Senior Energy Analyst, The PRICE Futures Group

Geopolitical risk from both a possible conflict in the Middle East and US-China trade tensions pressures both the supply and demand side of crude oil, writes Phil Flynn.

Oil prices got another jolt to the upside after reports that a Saudi-led military coalition in Yemen carried out several air strikes on the Houthi-held capital Sanaa yesterday. The move was in retaliation for earlier drone strike attacks that the Iranian backed Houthi rebels took credit for. This is raising the stakes and risks around the globe’s most strategic transportation routes and a potentially escalating conflict between major oil producers Saudi Arabia and Iran.

The Saudis for their part are calling on the United States to help carry out airstrikes on Iran, but President Donald Trump is wary of getting into a war. The New York Times reports that he is telling the acting defense secretary, Patrick Shanahan, that he does not want to go to war with Iran, while his senior diplomats began searching for ways to defuse the tensions.

Still the risks of conflict are great and the possibility of miscalculation by either side is very high. Reports are that Iran’s Islamic Revolutionary Guards put missiles on boats that could be a direct threat to military ships as well as oil tankers. The cost of increased transportation is being priced into this week’s oil price move.

While we continue to focus on these risks, we still have a civil war in Libya that at some point could cut off their exports again. Yet France is leading a peace effort that may reduce those risks. Reuters is reporting that “French President Emmanuel Macron will meet eastern Libyan commander Khalifa Haftar in the middle of next week to discuss how to resume peace talks in the country, a French presidential source said on Thursday. Macron last week called for a ceasefire in the month-long battle for Libya’s capital Tripoli after meeting U.N.-backed Libyan Prime Minister Fayez al-Serraj.”

Then you have the demand side. Forget the trade war talks breaking down because China says the United States plays ‘Little Tricks’. Think Chinese stimulus. Like it or not, every time China has added stimulus it has made Chinese oil demand rise. Bloomberg News reports that “China’s government said that it will work to counteract the effects of more U.S. tariffs and keep the economy in a "reasonable range." The National Development and Reform Commission is studying the impact of U.S. tariffs and will roll out "responsive measures when necessary," spokeswoman Meng Wei said at briefing.”

So, in other words if we get a trade deal, Chinese oil demand will go up. If we don’t get a trade deal, China will add stimulus and oil demand will go up. So, Chinese oil demand will likelyvgo up in either scenario.

Are shale producers making money yet? Some are, but many are in debt now. Yet Dow Jones reports that “Amid investor pressure, U.S. shale operators have become far-more disciplined about capital spending. As a result, the IEA estimates that the sector's break-even rate is the WTI U.S. oil benchmark being at $50-55 per barrel. It currently trades at $63. Meanwhile, the agency notes that despite this year's oil-price bounce, "operators have reiterated their commitment to not increase spending." While U.S. shale firms weren’t profitable as a whole last year, amid the end-of-2018 price slump, cash flow and investments rose significantly.

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