Last week, a UK Navy vessel interposed itself between a British-flagged oil tanker and several small boats that attempted to impede its passage through the Strait of Hormuz. The British Foreign Office attributed the event to Iranian forces. Iran has denied those allegations. Less than a week before this incident, Gibraltar law enforcement, assisted by UK military forces detained an Iranian oil tanker entering the Mediterranean, for alleged violations of Syrian sanctions. And reports have emerged that Iran has seized a British tanker at the Strait of Hormuz less than 24 hours after an incident in the same vicinity the day before, where the USS Boxer downed a drone following a series of reportedlyintense encounters with the Iranian military. The situation is about as complicated as it gets and has further stoked fears of possible disruptions in the oil market, which has witnessed a spate of oil facility and tanker attacks in the Middle East over the course of the past 2 months.
With Iran continuing to successfully deploy plausible-deniability tactics, the series of sabotage attacks on tankers have served to further escalate tensions with the United States and its regional allies and heightened tensions for commercial shipping in the Persian Gulf but resulted in no engagement between forces to date. These events have also come at a time of geopolitical uncertainty for many countries given musings by President Trump last month questioning the need for continued US military presence to defend the waterways in the region. The following analysis takes a deeper look at these events, the threat that they pose to the oil market, and how the current strategy to protect oil flows from the Persian Gulf is evolving.
The most recent episode involving three, allegedly Iranian, paramilitary vessels and a British-flagged oil tanker transiting near the Strait of Hormuz is just one in a series of events of this nature to make headlines in the oil market in recent weeks. A few weeks earlier, six tankers were sabotaged over the course of a single month in the Gulf of Oman, and, in the wake of these attacks, Iran shot down an unmanned US surveillance aircraft over the Strait of Hormuz. And, while the vicinity of the Strait of Hormuz has become the epicenter of the most recent string of strikes on oil assets in the Middle East, other strategically important areas for oil production and flows have witnessed assaults over the course of the past year as part of a wider escalation of tensions in the region. In particular, the Bab el-Mandeb Strait, and southwestern Saudi Arabia, was home to a series of attacks on oil facilities and tankers about this time last year, which at one stage led Saudi Aramco to temporarily suspend its oil shipments through this route. More recently, (19 June) Western oil companies operating in Iraq fell victim to rocket attacks at the Burjesia site just outside Basra, and, in May, Saudi Aramco also reported drone attacks at two pumping stations along the East-West pipeline, which acts as a means to bypass the Strait of Hormuz. The United States has linked each of these attacks to Iran, whether it be directly through the activities of the Islamic Revolutionary Guard Corps or by way of its support of the Houthis in Yemen or factions in southern Iraq.
These events are not unprecedented, but it is not normal. Iranian forces have been accused of antagonizing US Navy and international commercial shipping in and around the Strait of Hormuz for years. Until recently, threats—rather than violence—predominated as the means of intimidation. The last time the Persian Gulf witnessed attacks of this nature was more than 30 years ago, when Iran and Iraq attacked numerous oil-bearing vessels, in what is now known as the Tanker War. There was some concern at the time over the risk to the continued international flow of oil, though this did not materialize in a significant way. However, as the current vice chairman of the Joint Chiefs of Staff, General Paul Selva, highlighted, the situation is very different to the 1980s in part because of Iran’s tactics but also because the United States may have difficulty in forging an international coalition for any military response.
The recent attacks are dangerous signals to international energy markets and suggest a willingness by Iran to impede international access to the Strait of Hormuz, a threat, which Iranian IRGC senior officials previously made in 2018 in the run-up to the United States reimplementation of secondary sanctions on its oil exports. At that time, Iran’s exports were still flowing freely and, until May 2019, continued to do so but at a reduced rate because of sanction waivers. Now that the US administration has decided to no longer permit any volumes through waivers, the incentive for Iran to keep this vital shipping lane open and free from impediments seems to have diminished in favor of illustrating their capability to disrupt flows for other exporters.
The Strait of Hormuz is the world’s most important oil chokepoint. According to US Energy Information Administration, data exports of crude oil and petroleum products through the strait amounted to 20.7 million B/D in 2018, accounting for approximately one-third of world maritime oil trade (or 21% of global oil consumption). Some of the oil that transits the strait could reach global markets through slower and less efficient channels, but closing the strait could reduce global oil supplies by up to 15 million B/D. The importance of the Strait of Hormuz to global liquefied natural gas (LNG) markets as well should not be overlooked. Working from BP data, 25.6% of global LNG exports make their way through this passage primarily by way of Qatar but also from the UAE. And, while maritime natural gas trade represents a relatively small proportion of global natural gas demand (with these flows only accounting for 3% of global consumption), the more regional and less global nature of the gas market (relative to oil) means that any disruptions to these flows could have severe energy pricing impacts for LNG dependent importers.
The vast majority of oil production in Saudi Arabia, Iraq, the UAE, Kuwait, Qatar, and Iran is exported to customers through the strait. Alternative routes to this passage are severely limited. Saudi Arabia and the UAE are the only two countries with operating bypass pipelines to get oil to port outside of the Persian Gulf. Saudi Arabia has the East-West pipeline, and the UAE maintains the Habshan-Fujairah pipeline. Combined, they could accommodate an additional 3.5 million B/D or 17% of current Hormuz oil exports. However, even these routes have not been free from attempted attack. In May, Saudi Aramco reported two drone attacks on the East-West pipeline and a total of four tankers were sabotaged in and around the UAE port of Fujairah.
More than 75% of exports that leave the strait are destined for Asia. In terms of volumes, China is the largest importer of oil from the region; however, given the size of its overall demand for oil, it is not the most reliant country on these flows. Japan, South Korea, and India are particularly dependent on these exports, with these volumes accounting for the vast majority of their imports. And, even though the United States is quickly transitioning toward net oil exporter status, it still imported 1.35 million B/D through the strait in 2018.
The chart below shows the immediate vulnerability of Japan, South Korea, and India to any potential disruption at the strait. However, given the fungibility of oil markets, the pricing impacts of an extended disruption would not be confined to these markets alone but would be felt globally. The net oil import dependence of Japan, South Korea, India, and China though, would mean that the economic impacts of an oil price shock caused by any cutoff at Hormuz would be much more severe when compared to the United States, which is nearly a net exporter and may soon become a beneficiary of higher prices. The US economy, however, would not escape unscathed. The global inflationary knock-on effects caused by an oil price shock would severely limit world economic growth, which would ultimately translate into damaging effects for the US economy by way of reduced demand and investment, not to mention the damaging effects that significantly higher domestic gasoline prices would cause.
While prices initially increased when news broke of the last two tanker attacks on 13 June, most of this reversed by the close of the next trading day. The bearish sentiment at the time caused by oil demand concerns appeared to overpower the threat of restricted flows from the region. The most recent price increase was related to the significant draws in crude oil inventories in the United States. However, these gains also reverted on the back of growing oversupply concerns. That being said, current tensions still likely carry some form of premium in the market, but the consensus view is that tanker traffic will continue under enhanced security measures, despite recent comments by the president questioning the need for the United States to be involved in these efforts and the attendant increase in tensions for shipping.
Read the full story here.
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