Oil spill-overs | June 16th 2014
Why Iran’s role in the Iraq crisis is critical for everyone | Oil prices have climbed this month amid uncertainty about Iraq’s security as ISIS took control of Iraq’s second city, Mosul, and threatened to establish a Caliphate across Northern Iraq and Greater Syria. The region is oil-rich and the dangers of spillover into other countries in the region potentially puts further upward pressure on oil prices just as the crisis in Ukraine was beginning to be priced into markets generally and oil markets in particular.
Against this backdrop, the consequences of Iran’s decision to mobilise troops to fight against ISIS, thereby supporting the Iraqi government and, by implication the US. This clearly presents diplomatic and security challenges to the US: it does not support Iran’s backing of Syria’s Bashar al-Assad and the idea of the US and Iran being on the same side may be unpalatable to the White House.
Nevertheless, the Iranian move is shrewd. It supports Iraq’s Shiite government as a regional strategic partner and, wanting sanctions to be lifted as it does, is moving to protect its economic and trade interests as much as its political ones. The Delta Economics Q2 2014 forecast for trade growth in the MENA region generally is just over 0.6% lower than our forecast in Q1 at 4.5% growth during the course of the year. But Iran’s total trade will grow by nearly 5.5% and its exports of mineral fuels by over 17%. it clearly has a lot to gain from closer relations with both Iraq and with the rest of the world.
Figure 1 | Oil Spillovers: Why Iran is increasingly important to the Middle East’s oil supply
Source | DeltaMetrics 2014
Asia is important as an export destination for Iranian mineral fuels, explained at least in part by the fact that sanctions have prevented substantial trade with Europe or North America historically. As a result, the country to watch is Turkey – simply because oil exports into Germany are routed through Turkey from Iran. Iran is Turkey’s largest crude oil importer.
From an Iranian perspective, however there is potentially a stabilising effect on oil markets that its decision to intervene in the crisis could have. If Iraq’s oil increasingly comes on tap, then any drop in oil supply from Iraq can be offset against increased supply from Iran. Figures 2 and 3 show how mineral fuel exports from both countries are predicted to perform to the end of 2014.
Figure 2 suggests that mineral fuel exports picked up sharply in the early part of 2014 but may suffer slightly from the fall-out of the current crisis in June and July, after then they will remain relatively static to the end of the year.
Figure 2 | USDm value of Iraq’s mineral fuel exports, June 2001-Dec 2014
Source | DeltaMetrics 2014
Figure 3 shows that Iran’s mineral fuel exports will actually follow a similar pattern to Iraqi exports and fall slightly towards the end of Q2 and into Q3 picking up only slightly in Q4. Mineral fuel exports to Turkey have been declining fairly systematically since the beginning of 2013 which potentially reflects the fact that Turkey has supported Syrian opposition rather than Al-Assad in Syria.
Figure 3 | USDm value of Iran’s mineral fuel exports, June 2001-Dec 2014
Source | DeltaMetrics 2014
Interestingly, however, this does not appear to have affected Germany’s imports from Iran which have increased since mid-way through 2012, despite the fact that sanctions still exist, reflecting, perhaps, Germany’s (and Europe’s) sustained concern about its energy security.
Crises in the Middle East always make markets nervous. Unsurprisingly the correlation with oil prices of MENA trade is very high at 0.98 since a higher value of oil trade historically also reflects higher oil prices. However, the correlation of MENA’s trade with key markets is very high: with the S&P 0.70, with Dax, 0.81, with the India BSE 0.91 and with the KOSPI, 0.92. If oil trade in the Middle East is weak, it makes both oil and equity markets nervous.
Remarkably, there is also a very strong correlation between Middle East mineral fuel exports with the Gold Spot last price monthly, as Figure 4 shows.
Figure 4 | USDm value of Middle East mineral fuel exports versus NYSE Arca Gold Spot last price monthly, June 2001- May 2014
Source | DeltaMetrics 2014, Bloomberg
This correlation is very marked up to the middle of 2012 but has looked increasingly negative since then. Gold is often used as a hedge against price changes but while prices rose over this period in emerging markets, they declined in Europe breaking the relationship. In spite of that, the correlation over the whole period is over 0.90: if Middle Eastern oil trade goes up, then it means that oil wealth is increasing and that demand for gold, as a result, will be higher. If oil exports increase towards the end of the year, we can expect higher gold prices then but in the immediate future, further price declines.
The Middle East is increasingly a source of oil for Europe as it attempts to reduce its dependency on Russian oil. Yet as the region is fraught with geopolitical risks, there are dangers to the speed at which trade growth will increase, especially if the Iraq crisis spills over across the region. The major beneficiary nation, however, will be Iran whose mineral fuel trade is forecast to grow the fastest of any country in the region. This is the results of loosening sanctions and the desire, especially in Europe to have a broader energy supply base.
But it is also arguably the result of Iran’s policy to create a Shiite power-base within the region. While in the short term this may stabilize markets: pushing oil prices down as more oil becomes available during the course of the year. It might be that the effect is to increase the likelihood of a bull run next month because markets again price all the effects of the crisis in. However, the division of the region on religious grounds is also visible through its trade making it vulnerable and volatile. This may well have longer term spill-over effects.