West Asia tensions may disrupt oil supplies if attacks reach Hormuz Strait

At present, the prospects for oil are looking better for consumers like India despite the escalating hostilities

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6 min read Last Updated : Oct 03 2024 | 11:33 PM IST

There is a 160-year history entwining wars and oil prices. During the American Civil War, which raged from 1861 to 1865, oil prices rose more than six-fold. During subsequent conflicts — two world wars, several conflicts in West Asia, and Russia’s invasion of Ukraine — the increases were relatively muted, but prices still more than doubled.

The current conflict, involving Iran, Israel, Hezbollah, and the United States, resembles the Second Arab-Israel war of 1956-57, when Egyptian President Gamal Abdel Nasser seized the Suez Canal and closed it for six months, taking 10 per cent of the world's oil off the market. But oil prices remained stable, because production outside the region stymied a spike.

At present, the prospects for oil are looking better for consumers like India despite the escalating hostilities. There are no physical disruptions to supplies. China, the world’s biggest consumer, has slashed purchases of oil on account of a weak economy. The US, the world’s biggest oil producer, is pumping 13.2 million bpd, 13 per cent of global demand. There is new production from Guyana and Brazil.

In fact, Saudi Arabia is worried that crude oil prices could plummet to $50 a bbl if OPEC-plus does not adhere to output cuts, says the Wall Street Journal, citing delegates from oil cartel OPEC.

Supplies are so copious that Iran’s missile attack on Israel on Wednesday moved oil prices by only 5 per cent, compared to a 50 per cent spike in the first half of 2022 after Russia, the world’s second biggest oil producer, marched into Ukraine in February that year. Saudi Arabia-led OPEC-plus may withdraw 2.2 million bpd voluntary cuts in December as the Kingdom plans to preserve its market share and abandon a $100/bbl price target , says a Financial Times report last month. OPEC-plus members imposed a series of collective and voluntary oil production cuts since late 2022 of 5.8 million bpd to lend support to oil prices.

“Crude oil prices rose today (Wednesday) on fears that the war in the Middle East is going to get bigger and more intense after Iran fired missiles at Israel, with Brent crude close to $75 a bbl,’’ says Tilak Doshi, an international energy expert. “But the downside/bearish signals still hold strongly over global oil markets.”

China’s manufacturing sector continued contracting for the fifth straight month. Questions over the effectiveness of its latest stimulus plans, and poor data on manufacturing activity for Japan and Germany show signs of weak oil demand, says Doshi.

“Crude is up 3 per cent after a more than 2 per cent jump yesterday (Tuesday), so certainly the market is factoring in a risk premium,” says Vandana Hari, a Singapore-based energy expert. “But I don’t see $90 or $100 a bbl, based on the premise that Iran and Israel will be at pains to avoid an escalation that draws other regional powers in or the US into a full-fledged military conflict.”

Besides, the propensity of traders to drive up volatility fundamentals do not support high oil prices. The International Energy Agency forecasts 900,000 bpd of additional oil demand this year and 950,000 bpd in 2025, from 2.1 million bpd in 2023. Incremental output is more than sufficient to meet demand growth, with annual output gains strengthening to 2.1 million bpd in 2025. Non-OPEC+ increases contribute to 1.5 million bpd this year and next, the agency has said.

However, things can go horribly wrong only if the war stretches to the Strait of Hormuz, “the world’s most important chokepoint”, according to the US Energy Information Administration.

“Threats to transport via the Strait of Hormuz represent a much larger potential shock to global oil supplies than Russia’s invasion of Ukraine,’’ says a note by Benjamin Shoesmith, senior economist, KPMG Economics. “Any disruptions to that flow would have a major impact on prices.”

Iran has previously threatened to close the Hormuz Strait, 21 miles across at its slimmest point, and has seized tankers in that area. Shoesmith sees prices skyrocketing to $140 a bbl if the passageway is attacked before settling back to $80-$90 a bbl.

There is also a risk of attacks on Gulf oil infrastructure. When drones and missiles struck Saudi Arabian oil production facilities in September 2019, knocking out nearly half of the Kingdom’s crude oil production capacity, oil prices surged 20 per cent. But a Beijing-brokered truce between Iran and Saudi Arabia earlier this year, along with involvement of Houthis in the talks, may prevent recurrence of such attacks.

The only obstruction to oil flows from the West Asia conflict has been rerouting of cargoes after the Houthis started attacking tankers in the Red Sea since last November, prompting more expensive voyages around Africa. However, what could precipitate matters in the Strait of Hormuz is an Israeli attack on Iranian oil infrastructure in retaliation to this week’s missile attack, which would still need Washington’s blessings, says an Indian refining official.

Iran exports an estimated 1.5 million bpd, or 1.5 per cent of global demand. So, quantitatively, this is not a major issue in itself, but a widening of the war will be a key upside risk for oil prices, says Doshi.