Oil Prices Drop 6% Despite Trump's Iran Threat

Despite President Trump’s threat of “regime change” in Tehran following U.S. strikes on Iranian nuclear sites, the markets have reacted with calm and even optimism. Oil prices, after a brief spike, returned to pre-strike levels, and volatility indices dropped, while equities edged higher. Investors are unconcerned about major oil disruptions, reasoning that Iran is unlikely to close the Strait of Hormuz and harm its own economy.

Donald Trump threatened “regime change” in Iran early this morning and, counterintuitively, the price of oil declined back to roughly where it was prior to the U.S. bombing of Iran’s nuclear facilities. Sure, there was a brief spike in the price to $79. But the decline happened despite Iran’s threat to close the Strait of Hormuz, the shipping bottleneck in the Persian Gulf through which 20% of the world’s oil flows.

The VIX volatility index—the so-called “fear index”—was down 6% this morning and S&P 500 futures rose 0.22%.

Investors are calm in a world filled with war and chaos because Iran’s options in terms of disrupting the oil market are actually quite limited. First, if Iran closed the Strait, the country it would hurt the most would be itself. Iran needs oil revenues as much as the rest of the world needs Iranian oil. And the U.S. would barely feel the closure of the Strait because it buys very little oil from the Gulf region. The predominant buyer of Iranian oil is China, which is an ally of Tehran … so you can see why investors don’t think that Iran is going to shoot itself in that particular foot, and why Iran has not actually closed the Strait yet.

Historically, it would be extremely unlikely for Iran to actually block the shipping route. The Iranian regime has never done that in its five-decades of existence. And if it did so, it would strengthen the U.S. dollar—which has been through a weak spot of late. (Oil contracts are settled in dollars so if the price rises the demand for dollars increases likewise.)

Investors are beginning to suspect that Saturday’s bombing looks more like the closure of a period of uncertainty rather than the beginning. The current situation is that Iran’s air capability is gone, its nuclear weapons program is at the very least heavily damaged, it has a limited ability to punish the world with higher oil prices, and its military retaliation against further bombing by Israel overnight consisted of just one—one!—missile.

“A weakened Iran with no nuclear capacity removes the biggest threat to the Middle East and Israel which will be viewed as a positive for the market and tech stocks in particular as investors digest this news. The market will view this Iran threat as now gone and that is a positive for growth in the broader Middle East and ultimately the tech sector. It will take some time for this conflict to settle, but the market will view the worst is now in the rearview mirror with investors looking forward.”

Nonetheless, if Iran did suppress the oil market, what might that look like? There could be an “estimated geopolitical risk premium of $12” on each barrel. “We consider [there might be] two types of oil disruption scenarios, not in our base case: 1) reductions in Iran supply only ($80 Brent), and 2) broader disruption of regional oil production or shipping ($110 Brent).”