The potential disappearance of some 1 million barrels per day of Iranian oil, the continued decline in Venezuela’s production, and other geopolitical disruptions make for a tight market that can ill afford any further losses.
Attacks on four commercial vessels, two of them Saudi Arabian oil tankers, in the Gulf of Oman off the coast of Fujairah in the United Arab Emirates on May 12 have raised tensions in the Middle East and turned the spotlight on the Strait of Hormuz, the world’s most important oil transit route, and security of supply. On May 14, drones fitted with explosives launched attacks against Saudi oil installations. Houthi rebels in Yemen took responsibility for the drone attacks, saying they were a response to the Saudi-led military campaign against them. An official statement from Riyadh said there was no serious damage to the oil pumping station that was hit but that pumping through an oil pipeline to the port of Yanbu on the Red Sea had been halted.
The attacks on the oil tankers took place close to the UAE’s territorial waters near Fujairah, one of the world’s largest ship refueling stations. The emirate lies just outside the Strait of Hormuz and has become a valuable oil export terminal for the UAE, which built a pipeline to Fujairah amid Iranian threats to shut down the strait to all traffic if Tehran was not allowed to sell its oil due to international sanctions. Iranian officials have in recent weeks repeated the threat to close down the narrow strait after the United States declared its intention to drive Iranian oil exports to zero by scrapping exemptions that had allowed eight countries to continue importing Iranian oil.
Saudi Arabia and the UAE consider Iran a dangerous regional rival and have been supportive of the hard stance adopted by the administration of President Donald J. Trump. However, given the serious implications of the latest escalation, both Gulf Arab allies appear to want to avoid the blame game. The U.S. special representative for Iran, Brian Hook, said on May 14 that the United States did not want war with Iran, adding that the United States had beefed up its military presence in response to Iranian threats mostly “to send a message to Iran that if we are attacked we will respond with military force.”
These developments are bullish for the oil market. However, while oil prices rose slightly, the reaction, so far, has been subdued as there has not appeared to be an immediate threat to supplies. The loss of Iranian crude oil since the United States ended sanctions waivers on May 2 has already been factored into the oil market. However, the potential disappearance of some 1 million barrels per day (mb/d) of Iranian oil, the continued decline in Venezuela’s production, and other geopolitical disruptions make for a tight market that can ill afford any further losses.
Saudi Arabia and the UAE are among the few major oil producers in the region with capacity to increase production and make up for the Iranian shortfall. Should the need arise to plug any further supply gaps, OPEC would be stretched. Saudi Arabia holds the bulk of the world’s total spare oil production capacity. Saudi Arabia can produce 12 mb/d, so at current production of 9.8 mb/d, it can boost supply to make up for the loss from Iran. However, that would make its spare capacity cushion razor thin, something that goes against the kingdom’s policy of keeping 1.5-2 mb/d of spare production capacity available at all times.
Much of Saudi Arabia’s roughly 7 mb/d of oil exports are shipped through its eastern Gulf ports, though it also exports through the Red Sea port of Yanbu and the Suez-Mediterranean pipeline. The UAE too has the ability to ship more than half of its oil exports through Fujairah and recently announced plans to build the world’s largest oil storage facility in the emirate. Iraq, however, relies almost exclusively on its Gulf port of Basra with only a small volume of its oil exported by pipeline to Turkey’s Mediterranean terminal at Ceyhan.
Iran relies exclusively on the Strait of Hormuz to ship its oil, though it isn’t yet clear just how much of its crude will make it to markets in view of the U.S. determination to choke Iran’s economic lifeline. Qatar is also solely reliant on the strait for its crude oil and liquefied natural gas exports. Kuwait’s primary export outlets are its Gulf ports, and though it has access to the Suez-Mediterranean pipeline, it needs to transport its oil via the Strait of Hormuz to get it to Egypt’s Ain Sukhna terminal.
Pipelines Bypassing Hormuz
In all, an estimated 17.6 mb/d of crude and 3.3 mb/d of oil products transited the Strait of Hormuz in the first half of 2018. Alternative export routes have 4.4 mb/d of available capacity should oil exports need to be diverted. Complete closure, though considered highly unlikely, would likely result in a total supply loss of some 16.6 mb/d of oil (13.3 mb/d crude oil and 3.3 mb/d of oil products). Some 112 billion cubic meters of liquefied natural gas is also exported through the strait, mainly from Qatar, primarily to Asian customers. There are some export pipeline options to bypass the Strait of Hormuz, but they provide only 3.9 mb/d of additional capacity.
These sabotage attacks may have been a subtle message to the key players in the geopolitical arena of the Middle East not to escalate tensions in a region that is already a tinderbox. The Strait of Hormuz is a vital oil artery cutting through a very volatile part of the region. It is in the interests of all the littoral countries that derive their revenue from oil shipments – and all those states that depend on timely delivery of those shipments – to ensure that it remains a viable export outlet free from conflict.
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