Effects of Paris terrorism on oil price

History has shown us geopolitical events and crude prices go hand-in-hand

The terrorist attacks on Paris last week may be the stimulus for leading Opec countries to finally switch resources away from guarding their market shares to guarding their borders.

Geopolitical developments often have a major impact on oil prices as they can affect the oil supply directly, while the threat of future supply disruptions can build a risk premium into oil prices.

As a notable example, in the early part of 2014, conflicts in Libya and Iraq led to temporary outages in their oil production, keeping world prices high, even as supply elsewhere in the world continued to ramp up.

Production from those two countries coming back on stream was an important trigger for the plunge in oil prices later in the year. Notice (see left graph) how much oil price spiked at the historical times of war.

While the S& PG SC I Crude Oil has only recorded since 1987, the righthand chart goes back to 1947 by WTRG Economics, which shows spikes in oil price jumped more than two times on average during critical periods of conflict, including the Iran/ Iraq War, Iranian Revolution, YomKi pp ur War and Oil Embargo.

Generally, when there is a war, commodities perform well since it takes resources to fight awar and people will continue to drink coffee and eat cereal, which is the kind of fundamental economic diversification thatmakes this asset class important. Indeed, while stocks dropped during the Persian Gulf War, commodities rose.

In the recent environment, Opec is committed to maintaining market share in the global oil markets. Shortly after the natural gas deal was signed between Russia and China, Opec started flooding the market with oil to drop the price and force marginal producers to exit.

This also happened in 1986 when Opec dropped the price from $32 a barrel to $10, which may have led to the break-up of the Soviet Union. The current low oil price has divided the world by importers, exporters, developed and emerging markets.

Now, just as the world is agreeing on a chance for structural reform, the picture may change again. The Isis attack on Paris might be the catalyst to change Opec’s oil market policy of defending market share. Saudi Arabia may need to alter its focus to support defensive measures rather than maintaining oil market share.

There is a pivotal question about whether Saudi protects the long- term value of oil reserves or if they defend their role as the pre-eminent Sunni power in the region. Both are important.

On a different note, the other major commodity associated with waris gold, as it is known for its role as a safe haven in times of market crises.