When U.S. President Donald Trump recently announced that the U. S. was withdrawing from the Iranian nuclear accord, oil prices barely responded. That just shows how difficult it is to get ahead of conventional wisdom.
Immediately following the withdrawal announcement, the spot price of crude oil rose by only 2 percentage points—essentially receiving no real response from the marketplace. Despite the additional macro uncertainty this announcement creates, conventional wisdom seems to have already had this event almost fully priced in.
What Are the Implications?
That said, the U. S. bowing out of the nuclear deal with Iran will have some short-term and longer-term impacts.
First, it creates a bit of an uncertainty premium in short-term oil prices, but I don't expect much of an impact on longer-term prices.
Second, it creates some shifts in coalition powers as viewed from a game-theoretical perspective; namely it increases strains between the United States and Europe and creates more alignment between the United States and Saudi Arabia.
Short- vs. Long-Term Oil Prices
While most investors hone in on the spot price of oil, looking out on the forward curve provides an interesting investment perspective. The short-term spot price of oil was a little above $70 after the U.S. announcement—it has increased significantly, especially since mid-summer 2017.
But the price of oil for delivery three years out on the curve has traded in a tight range of $52 to $54 over that same time span. The small bump after Trump's announcement is just noise.
This is important to us as investors because the forward price of oil is more important than the spot price in determining the fundamental attractiveness of the energy sector. That is because it determines cash flows that can be generated by the assets in the sector.
We still believe that oil's equilibrium price range is $45 to $50 a barrel. We are not far from that range (looking out on the curve) and we do not expect the current spot price to remain this high for too long.
Some investors fear that oil prices could again become a proxy for the market as they did in the summer of 2015. We don't see any signs of that, nor do we think it will happen. In August 2015, it was an uncertainty about global growth, precipitated by a focus on China that prompted the alignment between crude oil and the market.
I don't think this current environment will mushroom into the same type of issue that we saw back then. That said, we remain cognizant of managing our energy exposure.
Trump's Shot Across the Bow of North Korea
Regarding the realignment of coalition powers around the world, we don't currently expect these shifts to have significant long-term investment implications. Still, we are going to re-examine our Middle East game theater to reflect the closer U.S. and Saudi alignment.
And the increased strains between the U. S. and Europe may impact trade and potential engagement with Russia in game theaters around the world.
At the same time, the U.S. nuclear deal withdrawal with Iran also is a bit of shot across the bow of North Korea coming into negotiations with Trump. It demonstrates to North Korea the hardline stance that Trump is willing to take.
Brian Singer, CFA, Partner
Head of the Dynamic Allocation Strategies Team
William Blair Investment Management