Muted market reaction to Saudi oil attacks underlines investors’ habit to underprice geopolitical risks

Markets have long struggled to assess and price political and geopolitical risks accurately, given our innate reluctance to prepare for worst-case scenarios

This explains, too, the reaction to a potentially disastrous no-deal Brexit

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Abdulaziz bin Salman (centre), Saudi Arabia’s energy minister, speaks during a news conference on September 17. The weekend attacks on the kingdom eliminated about 5 per cent of global oil supply and raised the risk of more conflict in the region, propelling Brent crude prices to a record surge on Monday. Photo: Bloomberg

Published: 10:00pm, 19 Sep 2019Updated: 3:36am, 20 Sep 2019

Another week, another indication of the pervasive influence of geopolitics on financial markets. Last weekend’s devastating attack on two major Saudi Arabian oil facilities – which knocked out half of the country’s output capacity, removing about 5 per cent of global supply – caused the sharpest daily increase in the price of Brent crude, the international oil marker, in a decade.

Not only was the sudden loss in output the single biggest disruption on record, exceeding both the loss of Kuwaiti and Iraqi oil production during the Gulf war in 1990 and the hit to Iranian output triggered by the Islamic revolution in 1979, it exposed the acute vulnerability of the oil infrastructure of the world’s largest exporter.

Yet, judging by the muted reaction to the attack in stock and bond markets – the benchmark S&P 500 index barely fell on Monday and is currently trading within a whisker of its all-time high reached in late July, while the yield on 10-year US Treasury bonds fell a mere 5 basis points – it would appear that investors are not that concerned.

On closer inspection, however, the reaction is not so much a sign of complacency as uncertainty, and, crucially, an innate reluctance to prepare for worst-case scenarios.

Investors have long struggled to assess and price political and geopolitical risks accurately. This is because, unlike financial and economic risks which are quantifiable and can be inserted into spreadsheets, threats that stem from political instability or changes within a country, or are associated with wars, terrorist acts or tensions between nations, are much more difficult to evaluate.