Oil was woken out of its slumber by yet another round of escalation between the U.S. and Iran, although the matter took on greater importance to oil markets only because of a more upbeat economic outlook.
In the early hours on Thursday, Iran shot down a U.S. drone, with both sides reporting conflicting accounts. The U.S. says the drone was in international waters, while Iran says that the drone had entered Iranian air space. The incident adds to the boiling cauldron of tension between the two countries.
“This was an unprovoked attack on a U.S. surveillance asset in international airspace,” said Navy Capt. Bill Urban, spokesman for U.S. Central Command.
“Borders are our red lines. Any enemy that invades these borders will not return [home],” Hossein Salami, the commander-in-chief of the Islamic Revolutionary Guard Corps said. “We don’t have any intention to go [to] war with any country, but we are completely ready for war.”
In early trading on Thursday, WTI was up more than 4 percent and Brent was up more than 3 percent, surging to the highest level since late May.
The Trump administration has a confused strategy on Iran, with the ultra-hawks John Bolton and Mike Pompeo in the driver’s seat and the slightly more skeptical President Trump yielding to his advisers. As such, it’s difficult to figure out who is calling the shots, and even trickier to predict what happens next. While Trump has been more circumspect, the Washington Post reported that Pompeo sent a private warning to Iran that a single attack on a single American anywhere would lead to a military strike.
But it’s important to remember how we got here. Last year, the U.S. unilaterally exited the 2015 nuclear deal and imposed crippling sanctions on Iran even though Iran was in compliance with the terms of the agreement. Then, the U.S. imposed a list of a dozen conditions that everyone understands as impossible for Iran to meet, essentially closing off any possibility of a negotiated settlement. Earlier this year, even as Iran remained in compliance with the nuclear deal, the U.S. sent warships and more troops to the region and attempted to take Iran’s oil exports down to zero.
The Trump administration calls it the “maximum pressure” campaign, and indeed, it has led to quite a bit of pressure. Iran has lashed out, at times through proxies, and also through its recent decision to resume stockpiling low-enriched uranium. These incidents are then used to justify the next cycle of escalation. With no off ramp, it’s completely unsurprising that the two nations are on the brink of war. The scary thing is that there still isn’t really an off ramp. Both sides seem locked into, at best, a lengthy simmering standoff, perhaps similar to what’s unfolding in Venezuela. Or they will go to war.
Surprisingly, the rapid spike in tension has only moved crude oil prices in fits and starts over the last few weeks. The prospect of a major war, and the potential disruption to maritime trade in the Persian Gulf, was largely shrugged off by oil traders.
But on Thursday, oil prices showed some signs of life, with WTI moving back into the mid-$50s and Brent in the mid-$60s, the highest price in weeks. The difference this time around is that financial and commodity traders have reasons to hope that a serious economic downturn may be avoided.
The U.S. Federal Reserve laid out a dovish position in comments on Wednesday. The central bank acknowledged low inflation and soft business activity, and while it noted that the economy remained strong, it conceded that “uncertainties about this outlook have increased.” The bank left interest rates unchanged but loosened some of its language. Financial markets took this as a shift in strategy, and are betting that rate hikes are in the offing, perhaps as soon as next month. Equity markets surged on the news.
Meanwhile, the other jolt of positive news came on the trade front. The U.S. and China confirmed a meeting between Trump and Xi Jingping next week in Japan, and trade talks will resume ahead of the meeting. Trump said on twitter that he had a “very good” call with Xi, and while the sticking points and in the trade war are still significant, and the chasm between the two sides remains wide, there is at least a glimmer of hope for a resolution.
Of course, the situation is dynamic – Fed rate cuts hinge on the outcome of the trade talks. But with some semblance of optimism on the economy for the first time in weeks, the bearish forces on oil lessened. Ultimately, that allowed the U.S.-Iran tension to move back to forefront, driving up oil prices, at least for now.