How the oil market learned to live with a Middle East in flames

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How the oil market learned to live with a Middle East in flames
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Hedges are the recipe for a market that’s capable of quickly shrugging off disruptions that until recently were considered nightmare scenarios

A dramatic U.S. drone strike kills Iran’s most important general. Tehran vows retribution and oil prices jump almost 5 per cent as traders rush to cover the risk of a Middle East war. Then the selling starts.

West Texas Intermediate crude, the U.S. benchmark, has slipped back below US$60 a barrel as the last of the gains from President Donald Trump’s standoff with Iran faded. That didn’t just reflect the easing tensions after Tehran’s retaliation for the killing of General Qassem Soleimani inflicted no U.S. casualties. It was a manifestation of how the shale revolution has changed the psychology of the market.

Crude prices are in the “sweet spot” for many North American producers, RBC Capital Markets analysts including Michael Tran wrote in a note. Many of them had been waiting, or hoping, for a chance to lock in WTI prices for 2020 at US$60 a barrel, a level that was pierced after the Soleimani killing. Each burst of hedging gives a boost to U.S. oil producers, potentially allowing them to maintain higher output at a time when analysts are expecting shale growth to taper. Later this year, some of the crude linked to these contracts may fill the network of pipelines, terminals and ports connected to U.S. Gulf Coast, further solidifying America’s position as an energy-exporting powerhouse that offers a low-risk alternative to Middle Eastern oil.

Though some countries have boosted production capacity, others like Iran and Libya have seen theirs slashed by sanctions and conflict. In contrast, since the middle of the last decade the U.S. has seen its own oil exports soar from effectively zero to more than 3 million barrels a day — more than is shipped by any Middle East producer besides Iraq and Saudi Arabia.

“Emerging-market crude inventories are much higher than they have been historically, especially in Saudi and China,” Goldman Sachs Group Inc. analysts including Jeffrey Currie said in a Jan. 6 note. “Both countries are already demonstrating their willingness to use these to stabilize supply and prices.”

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