GLOBAL MACRO | IN DEPTH Perspectives on Iran, the Middle East, and Oil How can Middle East tensions impact oil prices, stocks, the economy, and presidential elections? We explore past crises, the recent tensions with Iran, and our outlook. DEEPER ANALYSIS OF INVESTMENT TRENDS AND TOPICS January 16, 2020 John LaForge Key Insights Head of Real Asset Strategy » The Middle East produces a significant portion of the world’s oil, and geopolitical uncertainties in the region have a history of bringing volatility to oil prices. Austin Pickle, CFA Investment Strategy Analyst » While geopolitics involving the Middle East have become testy—to say the least—we have been anticipating this for some time (ever since the U.S. re-imposed oil sanctions on Iran in 2018). » We expect tensions to remain high, and we believe that our 2020 oil-price year-end target midpoints of $60 per barrel for West Texas Intermediate (WTI) crude oil and $65 per barrel for Brent best balance supply, demand, and these geopolitical risks. “Character and personal force are the only investments that are worth anything.” —Walt Whitman While geopolitics involving the Middle East have become testy—to say the least—we have been anticipating this for some time. Tensions between the U.S. and Iran have been rising ever since President Trump began pressuring its trading allies to stop buying Iranian oil in 2018. Iranian oil exports have since plummeted (Chart 1), along with government revenues. As it was pushed into the proverbial corner, Iran lashed out in 2019 by attacking oil tankers in and around the Strait of Hormuz, and drone-bombing Saudi oil facilities. Over the past three weeks, the conflict intensified with the U.S. killing key Iranian military leaders—and Iran launching missiles at U.S.-occupied military bases. And here we are. © 2020 Wells Fargo Investment Institute. All rights reserved. Page 1 of 10 Chart 1. Iran crude-oil exports by destinations 2500 2000 1500 1000 Thousandbarrels perday 500 0 2015 2016 2017 2018 2019 China India Europe Other Sources: Bloomberg, Wells Fargo Investment Institute. Monthly data: July 31, 2015 – December 31, 2019. Is the Middle East losing its sway over oil prices? Eastern politics. We disagree. Thirty-four percent is a Geopolitical uncertainties, especially in the Middle substantial share, and if the economic world wants to East, have a history of bringing volatility to oil prices. keep going around, we believe it needs OPEC’s oil. The reason is that the region controls a substantial With that being said, the slipping red line does suggest amount of oil resources. The red line in Chart 2 that OPEC is slowly losing its grip as the world’s highlights crude-oil production by the Organization of largest oil supplier. In 2006, OPEC’s share of world oil the Petroleum Exporting Countries (OPEC), which is production was 43%. largely composed of countries from the Middle East. OPEC is slowly losing its market share to the U.S. The As of last year, 34% of the world’s oil production came U.S. shale revolution has propelled the U.S. to the top from OPEC. of the oil-producing charts. The green line in Chart 2 Some say that the world does not need OPEC’s oil, and highlights that the U.S. now accounts for more than the West does not need to concern itself with Middle 20% of the world’s petroleum production. This number was less than 10% in 2006. © 2020 Wells Fargo Investment Institute. All rights reserved. Page 2 of 10 Chart 2. U.S. and OPEC oil production versus global oil production 48 Global production (right scale) 105 OPEC production as % of global (left scale) U.S. production as % of global (left scale) 100 43 95 38 90 33 85 28 80 75 Million barrels per day Oil production Oilglobal production of % 23 70 18 65 13 60 8 55 1980 1985 1990 1995 2000 2005 2010 2015 Sources: Energy Information Administration, Wells Fargo Investment Institute. Yearly data: 1980 – 2019. Does Iran still matter to oil prices? We believe the other factor in play here, that makes Does Iran still matter to oil prices? After recent U.S. Iran relevant, is that many of the oil fields in the sanctions, Iran’s oil production has dropped from 4 Middle East are large, concentrated, and in close million barrels per day to 2 million barrels per day, proximity to Iran. We witnessed the relevance of this which is only 2% of world oil production. Yet, Iran over the weekend of September 14-15, 2019, when Iran continues to make global headlines daily. Controlling sent drones “next door” to destroy one of the world’s only 2% of world oil production makes it look like Iran largest oil-processing facilities in Saudi Arabia. That doesn’t matter. And President Trump says that Iran attack should be a reminder to investors that Iran, and does not matter. Yet, Iran continues to make headlines, the Middle East for that matter, can still hold great and persistent conflict tells us that this country does sway over global oil prices. matter to oil markets. Our take is that this is because Middle Eastern oil still matters to global oil markets. Iran, even while it only produces 2 million barrels of oil per day, has proven politically adept at meddling inside the other OPEC-member countries. © 2020 Wells Fargo Investment Institute. All rights reserved. Page 3 of 10 The history of Middle Eastern crises’ impact on Table 1 highlights average oil performance following oil prices 20 Middle East crisis events, since 1990. These events are shown in Chart 3. History suggests that when turmoil in the Middle East hits, investors should expect to see volatile oil prices. Table 1. Average Brent crude performance around Middle East crisis events 1 month before 1 month after 3 months after -0.2% 4.5% 8.0% Sources: Ned Davis Research Group, Bloomberg, Wells Fargo Investment Institute. Please see end of report for list of crisis events. Chart 3. Middle East crisis events and oil price Northern Mali conflict 160 Lebanon crisis Islamic unrest in Egypt Anbar clashes Israel and Lebanon Iraqi civil war bombings Iran drone strike 80 Al-Qamishli riots Iraq War Yemeni civil war Gulf War 40 Turkish coup attempt U.S.S. Cole bombing Gaddafi overthrown Oil price (U.S. dollars per barrel) per dollars (U.S. Oil price 20 Arab spring begins War in Afghanistan Iraq uprisings South Yemen insurgency Bombing of Iraq Israel invades Gaza 10 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 Sources: Bloomberg, Ned Davis Research Group, Wells Fargo Investment Institute. Daily data: January 1, 1990 - January 9, 2020. Oil prices are represented by the West Texas Intermediate Cushing crude spot price. Past performance is no guarantee of future results. © 2020 Wells Fargo Investment Institute. All rights reserved. Page 4 of 10 Middle East crises’ impact on stock-market average, about three months, and then they fade as the performance peak risk to oil supply fades too. One point of note, though, is that these crisis events As for the impact on stock markets, we have found that historically have been short-term risks and not years- Middle East crises have had little lasting impact. The long threats to oil supply. As a result, oil price volatility blue line in Chart 4 represents the average has not tended to last very long on average. The performance of the S&P 500 Index. Notice that the U.S. vertical black dashed line in Chart 4 represents the stock market, typically, tends to shrug off turmoil in start of the 20 Middle East crises, since 1990. The the Middle East, even during the initial oil price spike orange line highlights the average oil performance (Chart 4, orange line). going into—and coming out of—Middle East crisis events. Notice that initial oil price spikes last, on Chart 4. Performance of stocks and oil around Middle East crisis events 112 110 108 106 104 Indexed value 102 100 98 Average S&P 500 Index performance Average WTI oil performance 96 -90 -60 -30 0 30 60 90 120 150 180 210 240 270 300 330 360 Calendar days around start of crisis Sources: Bloomberg, Ned Davis Research Group, Wells Fargo Investment Institute."0" indicates the start of the crisis. Indexed to 100 as of crisis date. Lines indicate the average performance of S&P 500 Index and West Texas Intermediate (WTI) oil price. Daily data: crisis events from 1990 to present. Please see end of report for list of crisis events. Past performance is not a guarantee of future results. © 2020 Wells Fargo Investment Institute. All rights reserved. Page 5 of 10 To be clear—it is not that oil prices do not have an prices surpass this 30% (higher) level. In other words, impact on stock markets. They certainly can. The sustained spikes in the price of oil have been a impact is usually felt, however, when oil prices have headwind to stocks in the past. been trending higher over a longer period than three months. The performance box in Chart 5 highlights Consequently, investors worried about the impact of annualized S&P 500 performance after oil prices have oil prices should look to see whether the Middle East risen by 30% or more over a year’s time. Notice how crisis event is one with "legs" to it. annualized stock gains slow dramatically after oil Chart 5. Stock performance versus oil performance Monthly Data: 01/31/1973 - 3200 S&P 500 Index 800 Index value 200 50 Stock performance when oil year-over-year rate of change is: Annualized return (%) % of time Above 30% 0.7 22.6 Between 0% and 30% 9.0 36.1 Below 0% 11.1 41.3 100% 80% 60% 40% 34.5% year - 20% over - 0% Year -20% -40% -60% Oil price year-over-year -80% 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 Sources: Bloomberg, Bureau of Labor Statistics, Wells Fargo Investment Institute.