[Editor's note: A version of this story appears in the February 2020 edition of Oil and Gas Investor. Subscribe to the magazine here.]

There’s a certain irony that even as it noted a 34% climb in West Texas Intermediate (WTI) prices last year, the initial 2020 edition of The Wall Street Journal carried a story on the risk of more levered E&Ps being unable to roll over upcoming debt maturities. If that sounds odd, it’s just a couple of the many themes that add up to an outlook that one research firm called “predictably unpredictable.”

And that was before events in the Middle East highlighted the unexpected incidence of geopolitical risk.

The killing of Iran’s major general Qassem Soleimani at the Baghdad International Airport in Iraq has led to heightened tensions in the Middle East and higher crude prices. The improved futures commodity curve for 2020, at around $60 per barrel (bbl) as of early February, has unexpectedly allowed E&Ps to hedge production at attractive prices and use increased cash flow to lower leverage or make returns to shareholders.

But the question for many observers remains whether the action taken to eliminate Soleimani will fade in terms of its impact on oil markets—somewhat similar to what happened following the drone attack on Saudi Arabia’s processing facilities at Abqaiq—or if the death of the leader of the Iranian Revolutionary Guard Corps’ Quds Force is a “game changer” leading to further escalation in military action.

Late last year, RBC Capital Markets’ head of global commodity strategy, Helima Croft, forecast that Iran’s Mideast strategy could bring it “closer to a direct confrontation” with the U.S.—albeit not quite the way it ultimately unfolded. And just a day before the death of Soleimani, “we continue to see Iraq as the potential tripwire for a direct clash between Washington and Tehran in 2020,” she wrote.

A day later, upon the death of Soleimani, “we think the stage is set for a retaliatory spiral that could keep markets on edge well into 2020,” observed Croft. Since Soleimani had overseen the activities of multiple armed proxy groups in Iraq and elsewhere, an “asymmetric response will likely involve the use of Iranian proxy groups throughout the Middle East,” she said.

 

As of this writing, Iran itself retaliated with one attack, involving 15 missiles targeting two U.S. military bases in Iraq. President Donald Trump said the attack inflicted “minimal” damage and no loss of U.S. lives.

“I think we’re set for a series of escalations,” said Croft earlier. “This was just too dramatic of an incident to let it pass without a response.” A short time later, a nonbinding resolution was passed with the backing of Shiite politicians, urging the caretaker prime minister of Iraq, Adel Abul-Mahdi, to rescind the country’s invitation to host U.S. forces in Iraq.

Some 5,000 U.S. troops are based in Iraq in the wake of the earlier mission to defeat Islamic State forces. The importance of the U.S. troops in the country is that it gives “Iraqi patriots confidence to counter Shiite militias armed by Iran and resist Iran’s strategic goal of making Iraq its political and military subsidiary,” said a commentary in The Wall Street Journal.

In terms of regions most at risk of seeing disruptions in production, Croft identified Iraq, followed by Libya and Venezuela. In the event that WTI prices should reach $70/bbl, the possibility exists that the U.S. administration could tap reserves held in the Strategic Petroleum Reserve, she said. Also, Saudi Arabia would likely be under pressure to increase production, she added.

In the swirl of geopolitical events post-Soleimani, Citi bumped up its 2020 price forecasts for both Brent and WTI by $5/bbl, to $64/bbl and $61/bbl, respectively. News of Iran’s retaliatory strike on the U.S. bases in Iraq prompted a $3/bbl jump to $71.22/bbl at the open for Brent, said Citi. However, prices retraced roughly 9% thereafter as a “tone of de-escalation” took hold in the absence of U.S. fatalities.

As with RBC, Libya is seen as an “area where geopolitical risks could crystallize sooner than expected,” according to Citi. What started as a civil war “may soon degenerate into a regional scale conflict,” with as much as 750,000 bbl/d of supply at risk. “A full disruption of supply, taking 700,000 bbl/d or more out of the market, would easily add $2 to $3 to Brent.”

At a time of heavy geopolitical consequences, much depends on parties avoiding miscalculations of risk.

Heightened geopolitical risks early in the year could influence not only the “likely price path of oil priced in 2020,” said Citi, but also the “probabilities of risks to the upside and downside.”