A hypothesis on oil, economic interests and geopolitical risk
Wars usually become visible only after they have begun. By then, armies are moving, sanctions have been announced, borders are being crossed and financial markets are already reacting. But the economic tensions surrounding a geopolitical event often develop much earlier.
One of the most important signals may be sitting in front of us every day: the price of crude oil.
Our proposition is simple, but it needs to be tested carefully.
If we can identify the normal or mean-reverting level of oil prices at different points in history, then an unusually large or rapid movement away from that level may provide an early indication of rising geopolitical risk. The signal could become even stronger when the new oil-price environment creates conflicting economic interests among powerful countries.In simple terms:
Watch the oil price closely enough, and perhaps one can detect the increasing probability of a major geopolitical event before the event itself becomes visible.
This is not a claim that high oil prices cause wars. It is a hypothesis that oil prices may contain information about the probability of future geopolitical events.
The price itself is not the signal
Oil prices have always been volatile. But volatility does not mean that there is no underlying economic equilibrium.
The equilibrium changes with global growth, inflation, production costs, technology, shale production, OPEC policy, inventories and the changing importance of oil in the world economy.
Therefore, the important question is not simply:
Is oil at $70, $90 or $110?
The better question is:
How far is today’s oil price from the level that the economic system would normally support at this point in time?
The hypothesis is that extreme disturbances may carry geopolitical information.
Oil does more than determine the price at the pump
Oil is also a mechanism for transferring wealth between countries.
When prices rise sharply, producers gain revenue while consumers and importing economies suffer higher costs. Inflation increases, trade deficits can widen and economic growth can come under pressure.
When prices fall sharply, consumers benefit but high-cost producers suffer. Investment declines, oil-exporting governments may lose revenue and countries dependent on hydrocarbons can face fiscal stress.
So an extreme oil-price movement does not affect every country in the same way.
The same $100 barrel can mean economic strength for one country, inflationary pain for another and strategic vulnerability for a third.
This is where economics begins to meet geopolitics.
Every major country has a different “comfort zone”
There may be no single oil price that is equally desirable for every major economy.
A large oil-consuming country may want prices low enough to protect consumers and control inflation, but high enough to maintain investment in its domestic energy industry.
A major oil exporter may have the opposite preference because government revenue and national finances are closely linked to hydrocarbon exports.
These differences create what we might call national oil-price comfort zones.
They need not be officially declared. They may never appear in a government document.
But the underlying economic incentives can still exist.
And when oil moves far outside one country’s preferred range while moving deeper into another country’s preferred range, the oil market begins to reflect a conflict of national interests.
From economic pressure to geopolitical pressure
Governments do not experience oil merely as a commodity price.
They experience it as inflation, economic growth, employment, fiscal revenue, foreign-exchange earnings and energy security.
For countries heavily dependent on oil exports, the price can also influence the government’s ability to finance public expenditure and strategic commitments.
The response does not necessarily begin with military action. It can start with strategic reserves, production changes, diplomacy, sanctions, protection of shipping routes or military deployments.
But when the perceived cost of waiting becomes greater than the perceived cost of acting, the threshold for extraordinary intervention may fall.
That is the part of the hypothesis that deserves serious quantitative examination.
Speed may matter as much as price
There is another important variable: how quickly oil is moving.
A gradual increase from $70 to $90 gives producers, consumers and governments time to adjust.
A sudden move from $70 to $100 can create a very different situation.
Inflation expectations change rapidly. Importing countries face an immediate shock. Producers suddenly gain financial strength. Governments become concerned about energy security. Markets begin to price scarcity.
The economic system has less time to adapt.
Therefore, our model should not look only at the distance from equilibrium. It should also consider the velocity and persistence of the deviation.
The central question becomes:
Does this combination improve our ability to predict geopolitical events out of sample?
The research already gives us a reason to ask
We are not starting from a blank sheet.
Shahbaz and co-authors, in Oil prices and geopolitical risk: Fresh insights based on Granger-causality in quantiles analysis, examined 18 geopolitically sensitive countries and found that the relationship between oil prices and geopolitical risk varies significantly across countries and across different parts of the distribution.
For China, India, Israel and Ukraine, the study found evidence of bidirectional relationships between oil prices and geopolitical risk. For several other countries, oil prices were found to have predictive power for geopolitical risk, while for Russia and Saudi Arabia the relationship was predominantly in the opposite direction.
Other research has similarly identified bilateral, asymmetric and time-varying relationships between oil prices and geopolitical risk.
Research on geopolitical risk and crude oil prices
Research on nonlinear dynamics between geopolitical risk and oil prices
These studies do not prove our hypothesis.
But they establish something important:
There is measurable information flowing between the oil market and geopolitical risk.
Our question is whether that information can be extracted before the geopolitical event rather than explained afterwards.
From hindsight to foresight
This is the real test.
Take several decades of historical oil prices and estimate the changing mean-reverting equilibrium. For every month, calculate the distance from that equilibrium, the speed of movement and how long the deviation persists.
Then add the economic interests of major countries.
Finally, ask what happened over the following 1, 3, 6 or 12 months.
Did geopolitical risk increase?
Did sanctions emerge?
Did military deployments increase?
Did a major conflict begin?
And, most importantly, would the model have identified the elevated risk before the event occurred?
That last question is critical.
With hindsight, almost any war can be explained.
The real test is whether the signal works without hindsight.
The proposition
We therefore return to the question with which we began:
Can monitoring oil prices help us predict the possibility of war?
Our answer at this stage is not “yes”.
It is:
It may be possible—and the hypothesis is sufficiently supported by existing evidence to deserve rigorous quantitative testing.
The most interesting variable may not be the oil price itself, but its distance from its changing mean-reverting equilibrium.
The signal may become stronger when that deviation is:
- unusually large;
- unusually rapid;
- persistent;
- economically damaging to one or more powerful countries;
- and beneficial to countries whose strategic interests conflict with them.
If a model can improve the prediction of geopolitical events out of sample, oil would acquire a very different significance.
It would no longer be merely a commodity-market indicator.
It could become an early-warning indicator of geopolitical stress.
Perhaps the oil market does not tell us that a war will happen.
But it may tell us when the world is becoming more vulnerable to one.
That is the hypothesis. Now it needs to be tested.
Disclaimer
This article presents a research hypothesis developed by Nomos Finergy for discussion and further quantitative investigation. It does not claim that oil prices cause wars, that governments deliberately initiate conflicts to manipulate oil prices, or that any particular geopolitical event can be attributed to oil-market conditions without independent evidence. The academic studies cited establish statistical relationships between oil prices and geopolitical risk under specific methodologies and samples; they do not establish the complete predictive framework proposed here. Rigorous testing would require appropriate econometric methods, out-of-sample validation, controls for reverse causality and confounding variables, treatment of structural breaks, and careful definition of geopolitical events. This article is intended for research and informational purposes only and should not be interpreted as investment, political or geopolitical advice.
Nomos Finergy