‘Rexit’ is the word flying around Wall Street today, as analysts absorb the impact of Donald Trump’s sacking of US Secretary of State Rex Tillerson – and wake up to its potential impact on oil prices.
Tillerson’s abrupt departure, and replacement with hawkish ex-CIA director Mike Pompeo, signals a major toughening of foreign policy by President Trump.
While former ExxonMobil chief Tillerson was seen as one of the more level-headed members of Trump’s team, Pompeo takes a hard line on issues like Iran.
Iran deal 'terrible'
The Iran deal saw the country accept limits to its nuclear programme and open its facilities to international inspections in return for a partial lifting of economic sanctions and the ability to sell its huge crude oil supplies on world markets.
Trump has been a vocal critic of the deal, and in a split from Europe, wants to reimpose sanctions unless Iran makes further concessions, while Tillerson had counselled on keeping the pact.
Talking to reporters after Tillerson’s sacking, Trump said: “When you look at the Iran deal, I think it's terrible. I guess he thought it was OK.
“With Mike, Mike Pompeo, we have a very similar thought process. I think it's going to go very well.”
The move puts the European signatories to the Iran deal – the UK, France and Germany – on notice that unless they can persuade Iran to make further concessions by the 12 May deadline, the US will reimpose sanctions.
“I'm surprised market participants are not realising the implications of 'Rexit’,” Helima Croft, global head of commodity strategy at RBC Capital Markets, told CNBC.
“Getting someone like Pompeo in that seat means the US may be far more willing to impose sanctions.”
Sanctions on Venezuela
It’s not just Iran where Pompeo’s influence will be felt. The US has also imposed sanctions on Venezuela.
The South American country has the world’s largest proven reserves of oil, but is on the verge of economic collapse after years of mismanagement by Marxist leader Hugo Chavez, and his successor Nicolas Maduro, who took over after Chavez’s death in 2013.
Chavez nationalised more than 1,000 companies, including oil companies and banks, and despite its natural resources, nearly bankrupt the country.
GDP collapsed by 19% in 2016 and inflation is running at more than 700% – that’s no misprint: seven hundred percent. Food and medicines are scarce.
As a result of President Maduro’s attempt to change the constitution to consolidate his power, the US imposed new sanctions last August.
That alone has meant a drop in exports of up to 800,000 barrels a day, according to RBC Capital Markets, but further sanctions threatened by Trump could see that rise to one million barrels a day.
“We are probably looking at both the US exiting the Iran deal and the US imposing more sanctions on Venezuela, and both of those are pretty bullish for oil,” Croft told CNBC.
Stuck in the $60s?
So will oil stay stuck in the $60s – or could the price go higher? Since the crash in oil prices in July 2014, when it fell from $105 to below $34 per barrel in just 18 months, crude has struggled to regain ground.
The fly in the ointment for the world’s main oil-producing nations is US shale oil, which becomes profitable to extract at just above $50 per barrel.
That price crash in 2014 came when, OPEC, the organisation representing the world’s big producers, tried to take out shale oil by flooding the market with cheap oil.
It worked in the short term, with many US rig contractors going out of business.
Then, towards the end of 2016, OPEC nations decided they had had enough of selling oil on the cheap, and tried a different tactic – turning off the taps.
Saudi Arabia persuaded a group of 24 countries, including the 13 other OPEC members and Russia, to curb global output by 2% to 1.8 million barrels a day.
The supply cuts pushed prices back up above $60 – but that just allowed the US shale-oil drillers to get back in business, pegging the price in the $60s.
Widening spread between WTI and Brent
Shale oil production has also affected the ‘spread’ in price between US oil, traded as West Texas Intermediate (WTI) and North Sea Brent crude.
As shale drillers try to lock in the higher prices seen of late by pre-selling future production, the WTI price has taken a hit, while Brent’s premium has increased, reaching its widest spread since 2015 of between $5 and $7 a barrel in October 2017.
That margin has narrowed slightly, with WTI is currently trading at $61.23 (12:47 GMT 14 March), compared with $65.17 for Brent.
It seems unlikely that either WTI or Brent will fall back below $60 in the near future. ‘Rexit’ could just tip the balance and push prices higher, if Trump turns the screw on Iran and Venezuela.
But the higher prices go, the more those drillers will be incentivised to resume fracking.
And as the world embraces increasingly embraces alternative energy sources, demand for oil continues to fall.
It’s a delicate balancing act, with a number of competing variables. Commodity brokers won’t be getting much sleep any time soon.