After posting the highest monthly gain ever in March, crude prices closed out Q1 almost doubling. March also saw the highest one-day jump in crude prices ever recorded. And that includes the massive 1970 oil embargo crisis, and both of the Iraq wars. However, it seems that markets (and economists) still expect things to calm down soon.
Tuesday could be the pivotal test for that, as US President Donald Trump has once again issued an ultimatum to Iran. He threatens to bomb the nation’s energy infrastructure and bridges if Tehran doesn’t agree to open the Strait of Hormuz by 02:00 AM CET (08:00 CET). But Brent is hovering just over $110 per barrel, and WTI is even higher, showing the market just doesn’t know what to do ahead of the deadline. In other words, look out for massive volatility going forward.
Another TACO Trade?
This is the third time that Trump has issued a very similar ultimatum over the last couple of weeks. The first time, it gave a 10-day period and caused the markets to push crude prices higher amid fears of escalation. However, this time around, it seems markets are pricing in a TACO scenario, since crude prices have not shot up and equity markets are modestly in the green.
In parallel to Trump’s threat, it’s also been reported that intermediaries are working on brokering a ceasefire between the US and Iran. Even a 45-day ceasefire has been suggested, which would practically be the end of the war. Markets, in all likelihood will consider a resumption of hostilities after such a long pause as being very unlikely. It’s pretty much routine now for Trump to issue serious threats in the final stages of negotiations to get last-minute concessions. So, it’s quite likely that’s what’s going on now, and that could explain why the market is fairly calm just hours before the deadline.
How Will the Market React?
There are three possibilities for what could happen. The first is that Iran concedes and opens the Strait of Hormuz, even if that doesn’t mean an immediate end to the war. The market is focused on oil supply, not the conflict itself. This could mean crude prices drop substantially. It might take traders a while to gain full confidence that the deal will hold, so the price may trend lower for a while. Crude could even fall below its level before the war started, as substantial inventory building has occurred in the meantime, and demand has declined.
The next option is for Trump to extend the deadline again, which would be the fourth time. This is the scenario that will likely have the least impact on the market, since it maintains the status quo. However, since crude prices have risen ahead of the deadline, they could decline to return to their regular war level, closer to $100 per barrel for Brent. The deadline could also simply pass without any comment from the White House, resulting in a similar outcome.
Markets Reacting To Uncertainty
If Trump carries through with his threat, crude prices could jump. But whether they remain elevated will depend more on Iran’s response. The fear is that Iran will follow through with its threat of retaliation against other Gulf nations, destroying oil infrastructure that will take months if not years to bring back online. But, US officials say Iran’s capabilities have been severely degraded, so they might not be able to mount a serious attack. Whether Iran chooses not to or is unable to attack its neighbours’ oil infrastructure, then crude prices could come down as markets accept that the major risk of the war is likely over.
One of the key indicators that markets are reacting to uncertainty is that spot Brent prices are higher than WTI. That’s because refiners prefer to buy from US and North Sea sources, which are more reliable and less likely to be subject to force majeure. The price differential represents a premium that buyers are willing to pay to offset the uncertainty over the conflict.
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