What Rex Tillerson’s Exit Really Means for Oil

Secretary of State Rex Tillerson’s firing — delivered via the now-traditional medium of Twitter, apparently — is being linked by some to his comments Monday night echoing the British government’s position that the poison used in an attack on a former Russian spy in the U.K came from Russia. As you may know, Russia a country with which President Donald Trump has an interesting relationship.

On the other hand, the president on Tuesday morning cited differences over Iran as the trigger. So maybe the winner here is actually Saudi Arabia — but only in the narrowest sense.

Saudi Arabia and Iran are the Middle East’s prime antagonists, and Riyadh would welcome a harder line from Washington against Tehran. And in Tillerson’s designated successor, CIA Director Mike Pompeo, they would appear to have their man.

In January, the president extended sanctions waivers as per U.S. obligations under the 2015 Joint Comprehensive Plan of Action (to give the Iran nuclear bargain its formal name). But he made clear he wasn’t happy about it and essentially said the deal would have to be fixed or nixed.

With another deadline for waiving sanctions coming in May, and (pending Senate confirmation) a newly-installed Iran hawk at the State Department, it’s possible the nuclear deal could begin to unravel this summer.

Yet if the clock is now ticking loudly on this linchpin of Middle Eastern diplomacy, the oil market seemed not to hear it on Tuesday morning:

There are several possible reasons for such apparent insouciance, the most likely being that, in the near term, surging non-OPEC oil supply smothers any geopolitical angst. Another is that while Tillerson’s ouster elevates an Iran hawk, it also demonstrates the chaotic nature of the Trump administration, making it tough to draw any conclusions about the direction of policy, much less wager money on it.

It’s also unclear whether U.S. abrogation of the deal would actually cut off Iranian barrels. Europe has been a big buyer of these since the deal went into effect, and China’s imports of Iranian oil have jumped too:

Europe, currently digesting President Trump’s proposed steel and aluminum tariffs and formulating retaliatory ones of its own, may well choose not to go along with Washington’s line. In that case, while the ultimate destination of Iran’s barrels might change if America withdraws, the absolute volume may stay the same.

That said, America pulling out of the deal might cause foreign oil companies such as Total SA of Franceto think twice about committing more investment in Iran (ironically, Russian oil companies might well step in if others step back). This matters because Iran is projected by the International Energy Agency to increase its capacity for oil production by 330,000 barrels a day through 2023, almost half the net increase expected for OPEC as a whole.

Blunting that would count as an extra win for Saudi Arabia, not merely denying dollars to its mortal enemy but also raising the prospect of oil supply tightening by the end of the decade.

The kicker for Saudi Arabia would be if this also brings forward harder U.S. sanctions against Venezuela, another country whose regime is in Pompeo’s cross-hairs. As I wrote here, the success of OPEC’s supply cuts to date owes much to Venezuela’s collapse. While Riyadh would never say so publicly, further pressure on Caracas would be a boon for Saudi coffers and a certain oil company’s planned IPO.

Such wins, if they can be called that, mask more insidious risks to the oil market on which Saudi Arabia, Russia and other petro-states depend.

First, any geopolitical premium in oil will also accrue to U.S. producers, whose enthusiasm tends to act as a brake on prices overall. This would be especially the case if that premium works its way into longer-dated oil futures, supporting hedging.

The second, and bigger, issue is how Tuesday’s news fits with a broader escalation of the administration’s economic nationalism. It comes soon after the announcement of tariffs and the resignation of Gary Cohn as the president’s top economic advisor. If Tillerson’s firing did have anything to do with his comments about Russia’s role in that poisoning in the U.K., then it would underline the fractures widening between the U.S. and its traditional allies; certainly, the White House’s response to that incident has been far more ambivalent than anything out of Foggy Bottom. And let’s not forget Trump’s continued push for U.S. energy dominance.

As Kevin Book of ClearView Energy Partners put it to me on Tuesday morning:

 The Trump administration has made a priority of closing trade gaps even as they are also opening rifts on foreign affairs.

Ultimately, the global oil market is a creature of free trade, as are many of the Asian economies, China included, that underpin demand growth. The geopolitical implications of Rexit may seem supportive of oil prices; the economic sub-plot is assuredly not.