Look for oil prices to spike if hostility between Iran and Saudi Arabia gets worse

Energy Shocks
Energy Shocks

If friction between Saudi Arabia and Iran persists, in addition to attacks on targets such as embassies, look for oil’s first move of the new year to be a spike.

A furor has erupted in both countries, and across the region, in the aftermath of Saudi Arabia’s execution Jan. 2 of Nimr al-Nimr, an influential Shia cleric who had denounced discrimination against Saudi’s Shia minority. An Iranian mob ransacked the Saudi Embassy in Tehran, and Ayatollah Ali Khamenei forecast that God would smite Saudi Arabia.

Angry rhetoric and demonstrations across the region probably won’t move oil prices: oil traders would likely take these, more or less, in their stride. The price of international benchmark Brent crude plunged by 35% last year, ending the year at $37.28 a barrel. Most analysts expect the price to remain more or less there through most of this year—perhaps falling to $20, perhaps rising to $45—before rising higher at the end of 2016.

No protests, whether in Bahrain or Istanbul (photo above), would change that outlook.

But if violence breaks out in Saudi Arabia’s Eastern Province—the location of most of its richest oilfields, and home to most of its Shia minority—that would be precisely the type of geopolitical event to bring higher prices early. Traders would smell a profit opportunity in betting on wild price spikes: up with the violence, and down again once the panic wears off.

As of now, there are no authoritative reports of trouble in the Eastern Province. Some local reports from the city of Qatif described street protests on Jan. 2, and the deployment of large numbers of government armored vehicles. A problem with the reports, though, is that they describe daytime protests, while publishing photographs of nighttime scenes of burning cars and attacked police, suggesting some photo-shopping.

The Saudis will move quickly to quash any violence, but the question will be whether they can keep any protests from flaring out of control.

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