(Bloomberg) -- Oil’s longstanding geopolitical risk premium has evaporated as traders interpret Donald Trump’s foreign policy agenda as bearish for oil demand — and prices.
Since Russia invaded Ukraine in 2022, oil futures have routinely traded above their so-called fair value, elevated by the threat of war-related supply disruptions. But that risk premium has faded, even amid persistent conflict in the Middle East and expectations that the president-elect will try to curb crude exports from major producer Iran.
In the options market, where traders often hedge against sudden price moves, the premium for bullish call options over bearish put options in Brent has disappeared completely, after activity had earlier in the year reached a record.
At the same time, a BloombergNEF gauge shows oil futures erasing all risk premium from the start of 2024. The war premium for Brent, which is currently trading at near $73 a barrel, is at a discount of roughly $2, the first time it’s gone negative since 2021.
That’s in part because oil investors are pricing in Trump’s foreign policy approach as bearish. Of 10 traders surveyed by Bloomberg, eight said that Trump’s proposals will limit price increases, with some suggesting a trade war with China will erode demand and potentially offset any new sanctions on Iran.
The absence of a risk premium is the latest indication that traders see little upside in the crude market, even with Trump in office. Oil futures have traded listlessly since the election, trapped in a roughly $5 range with investors increasingly reluctant to bet on hypothetical supply outages. That may prove positive for Trump, with lower crude prices setting the stage for cheaper gasoline at the pump.
Despite the possibility of escalation in the Middle East, traders are positioning for an oversupplied oil market capable of blunting any disruptions, thanks to record US shale production and ample OPEC+ spare capacity. These backstops didn’t exist in 2022, when Russia’s invasion of Ukraine shot prices to over $120 a barrel, said Rory Johnston, founder of oil consultancy CommodityContext.
By Johnston’s estimations, a risk premium hasn’t been visible in the market since April.
Bearish market participants also might be working off of memories of a risk-averse Trump who opts for economic pressure over military action, according Gregory Brew, a geopolitical analyst at the Eurasia Group. He cited a 2020 Iranian attack on a US base in northern Iraq in response to Qasem Soleimani’s assassination, which Trump chose not to escalate despite a chorus of hawkish advisors. That foreshadows a government that emboldens Israel in its campaign against Iranian proxies, without supporting a direct strike, Brew said.
Already, Iran has shown an unwillingness to clash with the incoming administration, agreeing to stop producing uranium enriched close to the level required for nuclear weapons.
READ: Iran Loath to Be Drawn Into New Clash With US as Trump Returns
Trump in his first term led the US in a maximum pressure campaign that significantly reduced the Islamic Republic’s exports. Investors believe he’ll attempt to target those flows again.
Yet such actions may have a clipped impact on crude prices with traders increasingly unconvinced that sanctions have teeth. When the US government last re-upped sanctions against Iranian oil in October, the commodity sagged by more than $5 a barrel in the next week.
“The consensus is that the US may have some success pushing down some Iran oil exports, but not all, and not in short order,” Brew said. Even so, the potential loss of up to 1 million barrels a day of Iranian crude “may not offset bearish signals to the extent that you have a higher price environment.”
Still, analysts warn that there are risks of going into a Trump presidency too bearish.
“Being short at the very front of the market will be difficult given the attendant risk and accompanying price gyrations, which were a market hallmark of the first Trump administration,” said John Kilduff, co-founder of Again Capital LLC.
He anticipates long put spreads to be a popular trade as traders hedge against the likelihood of a protracted sell-off.
--With assistance from Pol Lezcano and Yongchang Chin.
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