As War Rages on in Iran, Oil Itself Takes Back Burner to These Concerns

Oil Prices Climb as Refining Recovers

Iran is increasingly about energy products. But oil itself is not my main concern as we enter the second week of the invasion of Iran. It's about third or fourth on my list of worries.

It's true, oil is at the heart of things, but LNG is more problematic for me. Oil is more “fungible” and easier to move around than LNG. Those were some of the first facilities hit. Oil in and of its own is relatively useless. What is not useless? Gas, diesel and jet fuel. All are crucial.

So are chemicals. Plastics -- a lot of things that end in “ene” like polyethylene and benzene -- are not going to be produced. This is very noticeable right now. Search news streams for “force majeure”. These “downstream” products are critical to manufacturing. Asia (outside of China) is having troubles already. This is problematic and will take time to “fix” even once oil starts flowing.

We also have to worry about fertilizer. That is another element of our supply and food chain that is being impacted.

All of the above are a problem -- not just because oil is not flowing, but because these products are produced, to varying degrees, in the Middle East itself. They are directly impacted by the Strait of Hormuz not being used.

Shutdowns take time, but more importantly, so does turning these facilities back on. This is not like flipping a light switch. Knowing it can take one to three weeks to ramp back up to full production, is why people are reluctant to turn them off. Yet they are.

Relief?

Globally coordinated Strategic Petroleum Reserve release can help. This is not panacea. The total amount helps for weeks (not months). There is also concern about quality. The U.S. for example, has a lot of sulfur in the crude in our SPR. That makes it difficult to refine.

Treasury selling futures. Not optimistic on this. This is a “physical” problem, not a financial problem. There is very little indication that “speculation” is pushing oil prices higher. If it isn’t speculators, I’m not sure how much selling futures will help.

A deal. If we haven’t seen any progress on either transiting the Strait or a “deal” of some sort, by Friday, it will get more difficult to get a resolution without breaking parts of the economy for weeks (even months).

What a Deal Would Look Like

My base case remains: A “deal” will be made with some faction in Iran.

I believe this faction will be part of the existing regime -- we can expect no regime change. But the deal should come with the ability for U.S. companies to do business in Iran. I see it as kind of a Venezuela 2.0 – more complex, less malleable, but along those lines.

Ships should be able to traverse the Strait of Hormuz once any such deal is announced. But two things have changed and are causing me concern:

First, energy infrastructure is being hit. This is happening in Iran and elsewhere. I thought this would be more “hands off” like Russia/Ukraine but that has changed, not in a good way.

Pres. Trump has already signaled he is not happy with Iran’s choice for the new Supreme Leader. The choice does not seem like a good start for an off-ramp.

Tariff reduction?

I’m not sure it is the president’s nature to reduce tariffs on energy, potash, steel, aluminum etc. (though he did seem to encourage Russian oil sales), but that could be helpful too. So, I will be cautious on risk here. Europe is in worse shape than us.

I think this will be a “trading” market.

Fade bounces on “unrealistic” headlines. If something doesn’t sound believable, it probably isn’t it.

Don’t be afraid to take off hedges on big down moves. Liquidity is poor, and if you may be able to time reducing the size of hedges to reload later. Always a tricky proposition, but given the pace of headlines and their often contradictory nature, I think the opportunity is there.

At the time of publication, Tchir had no position in any security mentioned.