• Sun
  • Aug 31, 2014
  • Updated: 4:44pm
BusinessEconomy

Geopolitics explode again

The conflicts in Iraq and Ukraine are threatening to cause global economic turmoil but have failed to affect the prices of oil and stocks

PUBLISHED : Thursday, 26 June, 2014, 11:31am
UPDATED : Monday, 30 June, 2014, 7:28pm

Geopolitics has exploded once again on the financial market landscape, four years after the last surge in sovereign risk almost tore the euro zone apart.

The difference this time is that it is debilitating conflict, rather than dangerous debt levels, that threatens to ignite a major international political and economic conflagration.

There are two flashpoints for investors to worry about.

The most recent is in Iraq, the second-largest oil producer in the Organisation of Petroleum Exporting Countries and a pivotal country in the Middle East whose failure as a state would have significant repercussions for other nations in the region, in particular war-torn Syria.

The other is in Ukraine, the eastern half of which has been wracked by violence from pro-Russian separatists in the most dangerous East-West stand-off since the end of the cold war.

Ultra-low interest rates … are distorting asset prices and increasing the odds of … [a] correction

While the Ukrainian crisis has led to a further deterioration in the West's already strained relations with Moscow, the turmoil in Iraq has supplanted Ukraine as the focal point for market anxiety.

The stakes for Iraq, Syria, stability in the Middle East and global energy markets could not be higher.

Iraq is not just Opec's second-largest oil producer. It is also expected to account for two-thirds of the cartel's production capacity over the next five years, according to the International Energy Agency.

This projected increase in output is now "laden with downside risk", the agency says, because of the sectarian strife that is threatening to tear Iraq apart.

A fierce jihadist insurgency led by the militant group Islamic State of Iraq and the Levant (ISIL) risks bringing about the collapse of the country and the redrawing of its post-colonial borders.

The United States government, whose botched 2003 invasion of Iraq is deemed by many to be partly responsible for the current turmoil, is now mulling military action against ISIL - a move which could further inflame geopolitical tensions across the Middle East.

On Tuesday, ISIL gained control of the Baiji refinery, Iraq's main oil facility in the north which provides 60 per cent of the country's fuel supplies. Although most of Iraq's large oilfields are in the south - which for the time being is free of militant activity - Iraq's production and export flows are increasingly at risk.

If this is the case, then why has the reaction in commodity markets been relatively muted?

The spot price of Brent crude oil is just above US$114 a barrel, a nine-month high but a premium of only US$5 since ISIL captured Mosul, Iraq's second-largest city, early this month.

One explanation for the fairly benign reaction is that the crisis has not yet disrupted Iraqi oil exports, in particular those from the region of Iraqi Kurdistan, which has been something of a safe haven as the rest of the country descended into chaos.

Another, more troubling, one is that markets have been lulled into complacency by the determination of the world's major central banks to keep interest rates at exceptionally low levels until such time as the global recovery is on a firmer footing.

Indeed, even the Bank of England, which investors perceive as the least dovish of the main central banks and the one that is likely to be the first to raise rates, is dampening expectations of a rate rise later this year.

In the tug of war between central bank largesse and mounting geopolitical and country-specific risks, the ultra-accommodative policies of central banks have the upper hand.

Nothing it seems, not even a major jihadist insurgency in one of the world's largest oil producers, can significantly undermine market sentiment. The S&P 500 Index, the world's leading stock market indicator, is still hovering near the record 2,000-point high.

What's more, there is no sense in the markets that a major correction is imminent. Indeed quite the opposite. The prevailing view is that the rally is likely to continue throughout the summer amid remarkably low levels of volatility.

This should set alarm bells ringing.

Central banks are no longer part of the solution. Ultra-low interest rates - indeed negative ones in the case of the European Central Bank - are fuelling the "reach for yield", distorting asset prices and increasing the odds of an abrupt and disorderly correction once sentiment turns.

Identifying the precise catalyst for a major sell-off is difficult. What is clear, however, is that investors play down geopolitical risks at their peril.

Nicholas Spiro is the managing director of Spiro Sovereign Strategy

Share

For unlimited access to:

SCMP.com SCMP Tablet Edition SCMP Mobile Edition 10-year news archive
 
 

 

 
 
 
 
 

Login

SCMP.com Account

or