Paranoia Pays

The Oil Glut Camouflages Some Vicious Black Swans

Prices don't reflect the growing chances of conflict and chaos.

One of the more disconcerting consequences of climate change is how warmer water is quietly destabilizing large parts of Antarctica's ice sheet -- which might then in turn inflict catastrophic changes to sea levels everywhere.

This is how anyone in the oil market should be looking at the Middle East today.

As I noted earlier this week, the market appears largely indifferent to what's happening in a region that accounts for 36 percent of global oil exports, even when that includes a surprise reshuffle in Saudi Arabia's succession plans.

Essential Oils

While its share has fallen over time, the Middle East still accounts for more than one-in-three barrels exported around the world

Source: BP Statistical Review of World Energy

The most obvious reason for this is that traders just can't see past that big blob of oil inventories smothering the market.

What's more, when was the last time the Middle East wasn't a fractious place? And yet the oil has, more or less, kept coming. Looking further afield, even countries in such desperate straits as Libya and Venezuela are somehow still exporting hundreds of thousands of barrels a day each.

In fact, you have to imagine something really shocking to happen in the Middle East to take millions of barrels off the market: a war between Saudi Arabia and Iran, a direct confrontation between Russia and the U.S. in Syria, or the unraveling of the nuclear deal struck with Iran and what might follow. With low probability but very high costs, these are calamitous outcomes that are fiendishly difficult to model -- and even harder to discuss with clients or managers without sounding like you've read too many Tom Clancy novels.

Yet the risks of them happening are all appreciably higher today than just a few years ago.

Like that melting ice, some of the things holding the Middle East's conflicts in check are melting away.

Chief among these is certainty around the role of the U.S. This has accelerated under President Donald Trump's administration, but, as I wrote here, reflects a longer process of America reevaluating its post-World War II guarantees. The decline in U.S. dependence on oil imports contributes to this:

Not Over A Barrel

The Middle East remains a big source of U.S. net oil imports but has been declining in absolute terms for more than a decade

Source: BP Statistical Review of World Energy

Raad Alkadiri, a senior director at the BCG Center for Energy Impact and geopolitics expert, says:

This is an administration that is doing things differently. And it's being interpreted [by regional powers] through the prism of the old status quo.

In other words, there's a danger here of Middle Eastern governments hearing what they want to hear.

This most obvious example of this is the ongoing blockade of Qatar. This crisis blew up hot on the heels of President Trump's gala visit to Riyadh, which almost certainly emboldened the Saudi Arabian government to isolate Qatar as part of its proxy battle with Iran.

The current U.S. administration obviously tilts more heavily to Saudi Arabia in that overarching struggle. But how heavily? It isn't clear, with the confused messaging from Washington being just the most obvious sign. With regards to Qatar, Saudi Arabia may feel it has free rein. But how does that square with the fact that Qatar both hosts a major U.S. military base and massive investments by the likes of Exxon Mobil Corp?

The ambiguities were heightened this week by Saudi Arabia's change of leadership. While the elevation of Prince Mohammed bin Salman, known as MBS, caught most attention, the removal of former crown prince Mohammed bin Nayef as Minister of the Interior was just as important. He was very well-known to U.S. agencies and was running Saudi Arabia's most important ministry as well as its counter-terrorism effort.

With him gone, and MBS having consolidated power, the U.S. is dealing, in relative terms, with an unknown quantity -- and one that's liable to spring surprises, as the Qatar spat shows. Indeed, with Saudi Arabia having been whipsawed by two very different U.S. administrations in the past decade, MBS may feel compelled to move quickly against Iran while he can at least count on supportive tweets from Washington.

Equally, Iran must be feeling the heat. "Well deserved" would be an understandable reaction, but that misses the point.

Kevin Book of ClearView Energy Partners, a research firm based in Washington, D.C., points out the Qatari crisis and the Saudi Arabian reshuffle have come along in the context of stresses on the nuclear pact signed with Iran under the Obama administration. With Tehran testing ballistic missiles and active in Syria and the U.S. moving toward new sanctions, "both sides appear to be daring one another to cross the line" in breaching the nuclear deal, according to Book.

As all these moving parts feed off their own momentum, it is worth remembering the Middle East's major powers are habituated to pursuing what is euphemistically called a muscular foreign policy. The ongoing conflicts in Syria, Yemen and Iraq demonstrate the willingness of Saudi Arabia, Iran and others to sow chaos as a means to an end. And those war-zones constitute crucibles for further escalation.

The latter becomes more of a risk as those countries draw different conclusions about the intentions of the U.S. and suffer their own internal struggles due to lower oil prices. An oil market with its eyes firmly fixed on the seemingly rock-solid glacier at the surface is missing the quickening erosion of the foundations beneath.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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    Liam Denning in New York at

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    Mark Gongloff at

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