The oil crises of the 1970s taught Americans one of the iron laws of geoeconomics: that unrest in the Middle East can cause pain at the pump. But almost 40 years later, that law is blinding analysts to some of the most significant sources of market uncertainty -- which are right here at home. True, Iranian bellicosity and broader regional storm clouds are adding froth to oil prices. But even more striking is how much market-churning uncertainty is emanating from Washington and Brussels, rather than Caracas, Baghdad, or elsewhere in OPEC. The ambiguous economic trajectories and fluctuating policies of major energy-consumers like the United States, European Union, and China are proving at least as unsettling to oil prices as any decisions under the control of Middle Eastern officials.
Ask the leaders of OPEC what it's like to control the world oil market right now and they would probably laugh at your premise. Today's market jitters are largely beyond their control. The U.S. Federal Reserve's new open-ended commitment to expanding its balance sheet will likely push up the price of real assets like oil, even as White House chatter about dipping into the Strategic Petroleum Reserve (SPR) keeps the markets guessing about a sudden price collapse. At the same time, U.S. and European Union sanctions on Iran have crippled its oil exports, contributing to soaring oil prices and sparking demonstrations in downtown Tehran over the plunging value of the rial.
The potential for oil prices to shoot sharply higher or lower in the coming months due to events far outside OPEC's control is real, though still improbable. An Israeli military strike against Iran has the potential to drive oil prices skyward, just as the spread of Europe's debt crisis could cause oil markets to collapse. Add to this mix the threat of a so-called hard landing for China's economy or Washington falling over the fiscal cliff, either of which could send oil prices sharply lower. Yes, unrest in the Middle East is a continuous threat to stable oil prices, but political decision-making in the West and China is injecting more than its fair share of uncertainty into the market.
Part of this uncertainty is the result of policy incoherence in Washington. There is more than a little irony in the fact that the White House may decide to tap the SPR, the nation's 695 million barrel emergency fuel stockpile, to prevent a harmful rise in gas prices stemming in part from the decisions of the Fed. The mere announcement of the latest round of quantitative easing by Ben Bernanke, in addition to the already-loose monetary stance of other major central banks, was enough to send oil prices higher, only to crash shortly thereafter. The bounce would no doubt have been larger had many market participants not anticipated the Fed's decision. But the Fed's aggressive monetary easing is partly responsible for putting the Obama administration in the unenviable position of having to consider dipping into the SPR in order to keep a short-supplied market from pushing up prices too high.
And yet the policy dissonance in Washington has not been nearly so vexing to the oil market -- or to financial markets more broadly -- as the uncertainty surrounding the eurozone. Hardly a week passes without investors frantically buying or selling oil on the faintest whisper from the European Central Bank, Chancellor Angela Merkel, or the leaders of the most imperiled debtor nations. The unending lurch from Eden to Armageddon on trading floors around the world is typical of the so-called "risk on, risk off" capital-market mentality that has swept across every asset class -- and oil is no exception. Demand for oil correlates closely to global economic growth. When Europe's nagging ills appear on the mend, the outlook for growth appears brighter, causing oil prices to rise. Ditto on the flip side. But the sheer complexity of the problems facing European leaders, not to mention the uncertainty of domestic support for their policy prescriptions and the risk of cross-border contagion, mean oil prices have lurched to-and-fro with unusual velocity.