(John Kemp is a Reuters market analyst. The views expressed are
By John Kemp
LONDON, July 2 "Geopolitical risk" turns out to
have surprisingly little impact on the valuation of oil and most
Since the beginning of 2011, revolutions and
counter-revolutions have rocked the Arab world, sanctions have
slashed oil exports from Iran, and unrest has cut production in
South Sudan and Nigeria, and none of these events has had any
significant impact on oil prices.
The world's most important oil exporting region has
descended into chaos, with armed conflict within just a few
miles of some of the world's largest oil fields, yet the day to
day change in benchmark prices has been the smallest at any time
for more than 20 years.
None of the daily price changes so far in 2014 has reached 2
standard deviations let alone 3 or 4 (Chart 1). Volatility in
futures prices is near to the lowest it has ever been (Chart 2).
Chart 1: link.reuters.com/gev32w
Chart 2: link.reuters.com/jev32w
Calm is not confined to oil. Most other commodity markets,
like gold, and higher-risk asset classes like equities and
emerging market bonds exhibit the same tranquility.
In other regions, civil war has broken out in Ukraine, China
is locked in acrimonious maritime disputes with its neighbours,
the Communist Party is in the midst of the biggest purge since
the 1970s, Britain's relations with the European Union are
becoming increasingly strained, and Argentina is flirting with
But none of these political risks is evident in the
Entire forests have been felled as investment analysts and
financial journalists attempt to explain the "death of
Top-down explanations focus on the role of the major central
banks in supplying liquidity, pumping up the value of riskier
assets, and effectively guaranteeing investors against bad
Bottom-up analyses focus on all the other factors which have
helped offset rising political risks at a micro level.
In the oil market, for example, production losses from
Sudan, Libya, Nigeria, Syria and Iran have been almost exactly
offset by increased output from shale formations in North
Rebels from the Islamic State in Syria and the Levant remain
some miles from the main oil-producing areas in Kurdistan and
Actual production losses so far remain small and Saudi
Arabia has promised to hike production to meet any shortfall in
It is possible to rationalise the absence of volatility in
oil, commodities and other financial markets by combining some
of these explanations.
But it remains unconvincing. Most of the explanations are
based on long-term structural factors and should have been built
into prices long ago.
Markets are supposed to respond to new information. Some
sort of reaction to the news flow - much of which has been
dominated by international politics, and most of which has been
negative - should be evident in valuations.
In fact, geopolitical risk is arguably less important for
the pricing of oil, other commodities and financial assets than
most analysts and journalists assume.
Like many other professional analysts, my degree had a large
component of politics and international relations, and I find
the subject fascinating.
It is therefore tempting to assume politics and
international relations have a major impact on asset prices
simply because they dominate the headlines, are familiar to
writers, and are "big" events which should have big consequences
(displaying all the behavioural biases familiar to economists
But that overstates the role of geopolitical factors in
financial markets. In fact many of the biggest international
incidents of the modern era, including the attack on Pearl
Harbour, the Cuban Missile Crisis and the fall of the Berlin
Wall, had no discernible impact on markets.
Many big market movements, such as the stock market crashes
in 1929 and 1987, and the flash crashes in 2011 and 2012, had no
apparent political or economic trigger.
Iraq's invasion of Kuwait sent oil prices surging in 1990,
but by less than the spike in 2004-2008, which had nothing to do
None of this is meant to imply that geopolitics and
international relations have no impact on commodity and asset
There have been clear instances to the contrary, such as the
stock market crash which followed the attacks on the World Trade
Centre in New York in September 2001.
But geopolitics is only one of many factors which influence
financial markets and in most cases not the most important.
Engineering, business, social and economic developments are
usually more influential, if not always so obviously headline
History suggests geopolitical factors sometimes but not
always have an impact on perceptions about risk and asset
The more remote the risk the less impact it has on
valuations, partly because remote risks are likely to be less
important, and partly because their ultimate impact is much
harder to assess, and investors prefer to focus on risks that
are more easily quantifiable (those behavioural biases again).
If the foregoing analysis is true, it is not possible to
trade oil or other financial assets based purely or mainly on a
geopolitical view (which may explain why banks spend so little
time and money on international political research).
Investors who try to trade the market based on a
geopolitical view will probably, on average, lose money because
they overestimate the effect international relations has on
asset values in the short term. In fact the "smart money" is
probably trading against them.
(Editing by William Hardy)