(Bloomberg)– Oil markets are headed for even greater chaos on Monday as the war in Iran unleashes unprecedented disruption: Major producers are curbing production as storage fills and the most important waterway for global energy markets remains virtually closed.
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The United Arab Emirates and Kuwait have already begun to reduce oil production as storage runs out, joining Iraq, whose production is now down about 60%. Others may be forced to follow as tankers continue to avoid the Strait of Hormuz, rapidly reducing the number of empty tankers available for loading. Once all ships have been taken, the region’s remaining onshore storage will fill up even faster.
The unrest, now in its ninth day, shows no signs of imminent resolution, meaning a stretch of water that normally handles a fifth of the world’s oil is impassable. Saudi Arabia is diverting record amounts of crude oil to its Red Sea coast for export, helping to relieve at least some of the pressure.
Iran has vowed not to back down in the face of attacks by the United States and Israel that began on February 28. President Donald Trump responded Saturday by saying the United States would now consider attacking areas and groups of people in Iran that were not previously targeted. The attacks will continue “until they give up or, more likely, completely collapse!” he said in a social media post.
For oil analysts, executives and traders, that has meant increasingly loud warnings that the war is driving crude oil to a tipping point, and bringing it closer to the psychological threshold of $100 a barrel. Brent already rose 30% last week, its biggest jump in six years, putting it just dollars shy of that mark.
Markers closely linked to the region have already surpassed that level. Futures linked to Abu Dhabi’s flagship Murban crude settled at $103 a barrel on Friday, while Oman crude futures were at $107. Chinese crude oil futures on the Shanghai International Energy Exchange ended, in US dollar terms, at $109.
“Each additional day of disruption adds pressure, and in that scenario there is effectively no ceiling to prices in the short term,” said Stefano Grasso, a former physical energy trader who is now a senior portfolio manager at Singapore-based fund 8VantEdge Pte. Ltd.
There are growing threats to oil infrastructure, raising the risk of disruptions that could outlast attacks in the area. Saudi Arabia intercepted drones heading towards the Shaybah oil field over the weekend, with a production of 1 million barrels per day. Strikes have also continued in Bahrain and Qatar.
There is also the continued blockade of the Strait of Hormuz. In recent days, only oil tankers linked to Iran and two bulk carriers, which claimed to be Chinese-owned, have been seen in transit.
The effective shutdown has led Iraq’s output to fall to about 1.7 million to 1.8 million barrels a day, down from 4.3 million a day before the conflict, according to people with knowledge of the matter.
Meanwhile, Saudi Arabia is shipping unprecedented amounts of crude oil to its Red Sea coast. Shipments from its western terminals have increased at a rate of about 2.3 million barrels a day so far this month, ship tracking data compiled by Bloomberg show. While that is about 50% more than the kingdom has shipped from the Red Sea in any month since the end of 2016, it is well below the 6 million a day the country has exported from the Persian Gulf in recent months.
America moves
The United States promised to strengthen financial protection and potentially provide military escorts, and announced on Friday that it would implement maritime reinsurance for the Persian Gulf region. The fund will cover losses of up to about $20 billion “on an ongoing basis,” according to a statement.
On Sunday, US Energy Secretary Chris Wright said the oil market is currently pricing in a fear premium that won’t last. The war will only temporarily disrupt markets and shipping traffic, and the timeline for things to normalize “in the worst case” is weeks, rather than months, he said on CNN.
However, for shipowners and charterers operating in the region, the cost of insurance is not the main concern slowing traffic. Instead, they are concerned about the safety of ships and crew, and say they would need a full naval escort (similar to Operation Prosperity Guardian, a coalition to safeguard shipping in the Red Sea) or, preferably, an end to hostilities.
Other US measures to curb oil price increases include allowing India to access Russian oil currently in floating storage in the region. Washington has also thought about taking advantage of its strategic oil reserve or even intervening in futures markets; Officials have since downplayed these ideas, while Trump has downplayed inflation concerns even as U.S. gas prices soar.
“This is an excursion,” he said Saturday. “We thought oil prices would go up, and they will, but they will also go down, and they will go down very quickly.”
Import-dependent Asia, which relies heavily on the Middle East, is feeling the most immediate pain.
In Japan, which sources more than 90% of its crude from the region, refiners are asking for the option of drawing on national oil reserves. Others, including China, have curbed fuel exports to preserve supply and keep domestic prices in check. South Korea is considering resetting an oil price cap for the first time in 30 years, state news agency Yonhap reported on Sunday, citing government officials.
Meanwhile, in northwestern Europe, the price of jet fuel soared to an all-time high of $1,528 per ton (the equivalent of more than $190 per barrel) on Thursday, according to General Index figures dating back to 2008. The impact on jet fuel is particularly acute because half of European Union imports typically pass through Hormuz.
For analysts at ING Groep NV, the base case is now four weeks of disruption: two weeks of complete turmoil and two weeks of 50%, said Warren Patterson, the bank’s head of commodities strategy in Singapore.
“This scenario does not necessarily mean that we will see a complete end to the conflict in this period,” he said. “But if US and Israeli strikes degrade Iran’s ability to attack ships and enforce a closure of the Strait of Hormuz, we could see flows begin to normalize.”
The bank’s most dramatic scenario is a complete interruption of oil and liquefied natural gas flows for three months. This would likely send oil prices to record highs during the second quarter, the bank’s analysts wrote in a note.
–With help from Serene Cheong, Jack Wittels and Tony Czuczka.
