The markets have spoken, and they have spoken loudly. Crude oil prices plummeted this morning after reports emerged of a potential US-Iran peace accord. Brent crude, the international benchmark, fell by over 12% in early trading, wiping billions off the valuations of energy giants and sending shockwaves through the City.
For those of us who have watched the geopolitics of the Middle East with a cynical eye, this was a move waiting to happen. The premium that has been baked into oil prices for months, a risk premium rooted in the fear of a full-blown conflict in the Strait of Hormuz, has now been violently unwound. Investors are pricing in a new era of détente, and they are not waiting for the ink to dry on any agreement.
The question is whether this rally in peace is sustainable or yet another false dawn. The British government, ever the hopeful mediator, has already praised the move. But I cannot help but recall that similar optimism in 2015, following the JCPOA, was soon dashed by the US withdrawal and the re-imposition of sanctions.
The financial markets, however, are myopic. They see lower costs for businesses and consumers, and they are piling in. For the UK, this is a double-edged sword.
A drop in oil prices is a boon for our net import reliant economy. It eases inflationary pressures, gives the Bank of England more room to manoeuvre on interest rates, and puts more money in the pockets of consumers. But it also threatens the viability of North Sea production, which is already on life support.
And let us not forget the broader implications. If the peace accord includes a lifting of sanctions on Iranian oil exports, we could see a flood of supply onto a market that is already struggling with weak demand from China. The OPEC+ cartel, already fractious, could face its greatest challenge yet.
The beneficiaries of this collapse are the consumers and the governments that have been squeezed by high energy costs. The losers are the investors who have been betting on a sustained high-price environment. They will be licking their wounds today.
The fiscal hawks in the Treasury will be quietly relieved. Lower oil prices mean lower inflation, which means lower gilt yields, and that makes the government's borrowing costs more manageable. But for the energy sector, this is a day of reckoning.
The capital that has been flowing into oil and gas stocks is now looking for a new home. Where will it go? Likely into bonds, maybe defensive equities.
The talk of capital flight is premature, but the shift in sentiment is unmistakable. The bottom line is this: the market has priced in a peace dividend. If the negotiations falter, the rebound in oil prices will be swift and brutal.
For now, the City is betting on diplomacy. For the first time in a while, the bulls and the doves are on the same side.
