The US-Israel strikes on Iran have launched one of the most dramatic conflicts in the Middle East in living memory. Aside from military targets, Iranian forces have attacked commercial shipping and infrastructure in the region. The objective is simple: to disrupt oil exports and weaken its opponents' economies.
Author
- Adi Imsirovic
Lecturer in Energy Systems, University of Oxford
While the oil market is perfectly capable of absorbing short-term supply shocks, it is possible that the key protagonists, Israel and the US, may have very different war objectives . These differences could result in a widening and deepening of the conflict.
This could lead to a prolonged closure of the strait of Hormuz, which handles 25% of the world's seaborne oil and 20% of liquified natural gas (LNG) trade. China and India receive almost half of the exports and Asia accounts for 87% in total .
In response, China has banned petrol and diesel exports, an important source of supply for the rest of Asia. Japan and South Korea are also highly dependent on Middle East oil, but are wealthy countries with large reserves.
It is the poorer Asian countries such as Pakistan and Bangladesh , with only days of petrol and diesel reserves, that will feel the pinch.
And Europe receives less than 5% of oil via this route.
Sky-high prices
As a result, Asian buyers have turned to "benchmark" grades of oil from the Atlantic basin such as Brent and West Texas Intermediate, driving the oil prices higher. At the start of the second week of the conflict, the price of Brent, an international benchmark, was well over US$100 (£74.30).
However, the price of prompt, "safe" (Oman loads its oil exports outside the strait of Hormuz) Middle East-grade oil settled at US$124.68 for loading in May on the Gulf Mercantile Exchange (GME) on March 9. Some other oils (Abu Dhabi Murban and Upper Zakum, as well as Saudi crude) have been trickling out through small, alternative pipeline systems .
But the real shortage is for prompt barrels, loading in March and April. If available, this oil carries a large additional premium, often more than US$25 a barrel. What really matters to the end users is the price of oil delivered to the refinery - but shipping rates have increased many fold. Instead of US$6 freight before the war, for example, buyers are now paying well over US$15 for each barrel transported. As a result, the price of a delivered barrel of oil have already edged close to US$150.
Most Gulf oil producers are not in a better position. No new vessels are arriving to load the oil and storage tanks in ports are filling up fast.
Once the storage tanks are full, producers are forced to cut oil production. The most vulnerable producers are those with limited storage infrastructure: Iraq has already cut production . And Bahrain has announced a "force majeure" (an extraordinary event that is out of its control) for all its oil sales. Kuwait has followed with potential production cuts up to 1.5mbd.
So far the production cuts have been precautionary, but full shutdowns are damaging. It can take weeks to restart the fields and their long-term productivity may be significantly diminished because of shutting down.
From 1984-1988, during the Iran-Iraq war, around 550 commercial ships were attacked, killing hundreds of civilian sailors. In response, the US launched operation Earnest Will from 1987-1988, using navy ships to escort commercial vessels out of the Persian Gulf. In spite of this, tankers were still hit and many more sailors died. But oil kept flowing.
This solution is again being discussed in Washington , alongside providing affordable war insurance for shipping. The US International Development Finance Corporation, which usually helps the private sector to provide finance for developing countries, has been tasked with providing "affordable" (subsidised) war insurance.
Details of the proposal are unclear, but the fact remains that shipowners, operating in a market with very high returns, may not risk lives or their assets when they could very profitably operate other energy routes.
Another solution likely to be implemented soon is a release of oil from strategic stores - the largest release in history is reportedly now on the table. Countries in the Organisation for Economic Co-operation and Development (OECD) co-ordinate emergency stockpiles of at least 90 days' supply through the International Energy Agency (IEA), which was formed in the 1970s to manage impacts of the oil shocks at the time.
The world's commercial and strategic oil stocks are large. According to independent analysts Energy Intelligence, crude stocks could be sufficient to compensate for the closure of the strait for about 15 months. This assumes that at least 2mbd of Saudi and UAE production can be rerouted through alternative pipeline systems if the war goes on.
China, the US and Japan have particularly large reserves , possibly lasting for several weeks of average consumption (on top of any deliveries they receive).
IEA members have a long history of emergency oil stockpile releases. In 1991, during the first gulf war, they released about 75 million barrels; in 2005 after hurricanes Katrina and Rita about 60 million. Most recently, they released 180 million barrels in 2022, following the full-scale Russian invasion of Ukraine.
The US Treasury has been discussing measures to counter the rising energy prices by intervening in the oil futures market in a bid to bring prices back down. But this could be disastrous for the market as well as for the Treasury. On Black Wednesday in 1992, the Bank of England's attempts to defend the value of sterling led to multibillion-pound losses for the government.
The coming days are going to be crucial for the oil market. If the war continues, it is clear that both oil-producing and consuming countries face immense risks.
Adi Imsirovic does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.
