Persian Gulf insecurity threatens oil supplies

About 30percent of global oil production is in the Persian Gulf states with most of exports passing through the narrow Strait of Hormuz. Any geopolitical incident that significantly threatens interruption of oil shipments through the Gulf has the potential of upsetting the equilibrium of global oil supply with serious economic implications.

For many decades the Western powers (mostly USA), aware of geopolitical volatility in the Middle East, have maintained military presence in the Gulf, and this has helped maintain basic peace and prevented reckless hostile escapades among regional neighbours.

Last week two loaded oil tankers were attacked just outside the Strait of Hormuz by parties that the US says are linked to Iran and which the Iranians have denied any involvement. Similar targeted incidents had been experienced last month. The atmosphere in the gulf is already highly charged and polarised with the wider world (including the UN) urging restraint to avoid escalation and physical confrontations which would interrupt global oil and gas trade.

The genesis of the crisis is the re-imposition by the US of economic sanctions against Iran. These include a ban on Iranian oil and gas exports which are Iran’s socio-economic lifeline. The US pulled out of the 2015 Iranian nuclear deal which had lifted previous sanctions, reasoning that the nuclear deal is lopsided in favour of Iran.

Regional influences

On the face of it, it appears that the pull-out from the nuclear deal was to allow the US to specifically neutralise Iranian regional influences especially in Syria, Iraq, Lebanon, and Yemen. Isolated and apparently abandoned by the other 2015 nuclear deal signatories, Iran is certainly feeling economically and politically “cornered”, which is not a comfortable situation for any country to be in.

The US, Saudi Arabia and the UEA (and to some extent Israel) are clearly together on one side of an already escalating Middle East conflict. Iran is alone on the other side with “silent” sympathies from Iraq, Qatar and Turkey. An opinion is already emerging that the Saudis and Emiratis are in a hurry to see a physical action (facilitated by the US) against Iran, their long-standing regional Shiite enemy.

On the sidelines, Russia has apparently played its diplomatic cards smartly, emerging as the mature and “neutral” party in the Gulf squabbles. Although China’s sympathies are with Iran, its hands are evidently tied by the ongoing trade wars with USA, not ready to open a second “war-front” with the US.

Turning to the global oil markets, one would have expected the shipping attacks last week to trigger a sudden price hike in the market. The oil prices (Brent) have surprisingly remained in the $60-62 range since last week, which implies that the supply situation is unperturbed by events in the Gulf.

Global supplies

The Gulf attacks are happening when production outages in Iran, Venezuela and Libya have already removed significant volumes from global supplies. Further, ongoing oil production cuts by OPEC and Russia have also limited supply. The apparent indifference by oil markets to the Gulf attacks is an indication that the world is either over-supplied with oil, or that global demands are weakening. The demand angle is explained by reduced global economic prospects due to the ongoing trade wars between USA and China.

Going forward, the OPEC meeting later this month will assess the true global supply/demand position and agree on guiding policies and actions to control (or free) production. OPEC policies have previously targeted establishing and defending $ 70-80 oil price range.

With the 2020 US elections and consumer gasoline prices in mind, President Trump will also be playing his cards to influence his Middle East allies to put enough oil in the market to achieve his preferred “politically safe” target price of $ 65-70. Whichever way one looks at the global oil supply/demand dynamics, most of the cards are in Trump’s pocket.

Will the current situation in the Middle East escalate into a physical war? Every indication is that the US and indeed Iran will ensure this does not happen. The problem may be with the hawkish Saudi Crown Prince and the Emirates... Whichever way, war risk insurance premiums for gulf shipments are bound to increase.