Of all the factors standing in the way of any stock market gains in 2015, oil was most definitely the biggest impediment. The drag on world economies left the S&P 500 flat and going nowhere for the year. The outlook for oil prices into 2016 was not any better due to a continued global glut. Oil futures continued to be bearish.
Enter geopolitics and an unforeseen event to change things around at least temporarily. Oil futures rose slightly Sunday night following the execution of a Shia cleric by Saudi Arabia which sparked outrage in Iran and led to the burning of the Saudi Arabian embassy in Teheran.
Iranian Supreme Leader Ayatollah Ali Khamenei threatened the Saudi royal family with divine vengeance and Saudi Arabia immediately broke diplomatic ties.
Benchmark U.S. WTI light sweet crude zipped up 1.9 percent to $37.76 a barrel on the news in Asia, after jumping as much as 3.4 percent from the last day of trade in 2015, while Brent crude was up 2.3 percent at $38.12 a barrel after spiking 2.4 percent over the same period.
The Saudi-Iranian diplomatic break will continue to have a major impact on future oil prices as it pits the Gulf region's largest producers against each other and raises the stakes considerably just at a time when it looked like oil prices were about to drop even further. The heightened tensions between the two OPEC producers is worrying for investors as most Saudi oil production comes from its Eastern Province, which is dominated by Shiites and this is the area that could suffer the most if there is an escalation in friction between the two countries. Saudi Arabia produces about 10 million barrels of oil a day, while Iran's output is about 3 million barrels a day, so any potential supply or shipping disruption would have a significant impact on the market.
The Saudi-Iranian diplomatic break will continue to have a major impact on future oil prices as it pits the Gulf region's largest producers against each other and raises the stacks considerably…
2015 Selloff
The selloff in commodities, particularly oil, was among the more dramatic market developments of 2015, with West Texas Intermediate oil down 30 percent for the year at $37.04. Oil’s decline knocked 60 percent off energy profits and sent the S&P energy sector down 24 percent on the year.
Crude's losses were the result of massive global oversupply as well as the stronger dollar, which also wreaked havoc on emerging currencies. The dollar was up more than 20 percent for the year against the Russian ruble, Brazilian real and Turkish lira, to name a few.
Selling pressure on oil is expected to continue. Traders are watching Wednesday's 10:30 a.m. ET government inventory report to see if oil supplies continue to build as they did in the past week. Every Wednesday at that time, energy traders analyze and react to the headlines of the U.S. Energy Information Administration (EIA) Petroleum Status Report and provide data on the state of U.S. supplies. Changes in crude oil inventories help establish short-term crude oil prices and the weekly report analyzes this relationship to determine how changes in crude oil inventory levels affect crude oil prices.
Drop in U.S. Production Possible
The U.S. may be exporting crude for the first time in 40 years, but according to some analysts, production is likely to decline due to a significant reduction in capital expenditure amid the oil price rout.
Additionally, Russia, a non-OPEC supplier, is expected to also see limited output growth in 2016 due to capex (capital expenditure) cuts. With oil consumption likely to be strong this year the oil markets will have to rebalance themselves in the second half of the year, particularly if U.S. production continues to be slow.
Some market strategist worry that despite the friction, Saudi Arabia will decide to increase production to counter any fallout from the conflict with Iran, which could mean that a barrel of oil could easily hit $20.
There are concerns that Iran will resume exports following the lifting of U.S. sanctions but analysts see this as a longer-term risk and are more concerned that current geopolitical pressures could have an impact on oil supplies, as global spare crude oil capacity is "limited" at 2 million barrels a day.
One political expert points to the possibility of the conflict spilling over into other countries in the region such as Lebanon, Yemen or Iraq, posing a serious problem for the West in deciding which side to support. According to IG market strategist Evans Lucas, “This is a political conundrum of epic proportions and one that will push governments ethically and economically