Alleged Military Initiatives in Iran may Impact Oil Prices Further

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Alleged Military Initiatives in Iran may Impact Oil Prices Further

Concerns about Iran upping the nuclear ante were voiced at the recent IAEA meeting. Coming close on the heels of the report about an explosion in Saudi Arabia that allegedly damaged oil pipelines in Awwamiya, this development has impacted oil prices significantly.

Although U.S. President Obama was quick to broadcast his support for Israel and against Iran, the markets are still reacting to news about a possible war that would result in serious disruption to oil supplies. Binary traders who have bet on the price of this commodity need to factor in current happenings to make the right decisions about staying in the trade or pulling out.

A False Alarm that Lead to Very Real Price Hikes

The previous report about the Awwamiya oil pipeline being damaged was quickly denied by Saudi government officials, but not before it sparked off volatility in the price of oil. Soon after the report was aired by a state run news channel in Iran, oil price per barrel zoomed to over $110 for the very first time since May.

Political Tensions Prevail

Political tensions in this region of the world did not help matters along. Nor did U.S.’s hard stance against what Washington chose to construe as Iran’s war mongering. The White House had taken pains to reiterate that it would oppose military endeavours by Iran at all costs in this part of the world.

This was back when the news of the Saudi explosion rocked the markets. Fear of an impending war added impetus to prices of this highly volatile commodity. Now, with U.S. speaking for Israel and against Iran once again in the IAEA, the tension is bound to only escalate.

Atomic Activities at Parchin?

The recent U.S. reiteration comes after International Atomic Energy Head, Yukiya Amano brought the spotlight to indications of military style activities at Parchin, an Iranian military site. Visits to Tehran in the initial months of the year, by IAEA officials failed to confirm or refute the supposed military activities since they were denied access. Intelligence reports indicate that a large containment chamber has been built at Parchin. Iran has also tripled its refined uranium production per month.

Given this alarming information, fears of war initiated by Iran have gained intensity leading to speculation about how badly oil supplies will be hit if military manoeuvres do begin in these regions. Oil prices are bound to be impacted in coming weeks too until some clarity is gained on the issue.

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Iran Crisis: The Impact on Oil Markets

Professor Paul Stevens

2020-01-14-Hormuz.jpg

The assassination of General Qassem Soleimani has created much speculation about the possible impact on oil markets and – although any impact will very much depend upon what happens next in terms of political and military responses – theoretically the potential exists for Iran to seriously destabilize oil markets, raising oil prices.

Arguably, it would be in Iran’s interest to do so. It would certainly hurt Trump’s possibility of a second term if higher prices were to last for some time as the 2020 presidential election gets underway. And it would also help shore up Iran’s failing economy.

The assassination did initially cause oil prices to rise by a few dollars before quickly falling back, and the missile attacks by Iran produced a similar response. However, direct action by Iran to raise prices – for example by trying to close the Strait of Hormuz – is unlikely.

Around one-fifth of the world’s oil supplies passes through the Strait of Hormuz, a narrow choke point between Iran and the Arabian Peninsula. Closing it would invite serious military action by the Americans and many of its allies who, so far, have been rather lukewarm over Trump’s actions. It would also possibly limit Iran’s own oil exports.

Similarly, overt attacks on American allies in the region such as Saudi Arabia and the UAE would probably invite too heavy a reaction, although this is uncertain given the lack of response after the alleged Iranian attacks on Abqaiq and Khurais in mid-September.

Indirect action by Iran to affect oil supplies is much more likely as they have many options by using their proxies to affect others’ oil production. This is especially true for Iraq, which is now an important source of global oil supply as Iraqi exports in 2020 averaged 3.53 million barrels per day (Mb/d), a significant amount.

Iraq’s future production has already been damaged as international oil companies are withdrawing staff for safety reasons, anticipating potential attacks by both Iraqi and Iranian sources. It is now very unlikely that the crucial ‘common seawater supply project’ being run by Exxon – essential for expanding production capacity – will go ahead in the near future.

However, one important consequence of the assassination that has attracted little attention is that it has almost fully restored the role of geopolitics into the determination of oil prices. Up to 2020, geopolitics played a key role in determining oil prices in the paper markets where perceptions and expectations ruled.

Prices determined in these markets – NYMEX in New York, ICE in London and other lesser futures markets throughout the world – then influence wet barrel markets where real barrels of oil are traded.

In 2020, the world was so oversupplied with real oil barrels that the oil price collapsed – the price of Brent crude fell from $110.72 on 23 May to $46.44 eight months later. Thereafter, little if any attention was given to geopolitical events, and geopolitics became marginalized in the determination of crude oil prices.

This began to change in 2020. The market remained physically over-supplied but events in the Gulf began to attract attention. In June, there were a series of attacks on oil tankers close to the Gulf, followed by attacks on Saudi Arabia’s Abqaiq processing facility and the Khurais oil field in September.

The Americans claimed these attacks were launched by Iran, but no convincing evidence for the claim was provided. Both attacks produced an initial price response but it was surprisingly limited and short-lived. However, it did suggest that geopolitics might be creeping back into influencing oil prices.

This became ever more noticeable in the third and fourth quarters as rumours regarding the trade talks between China and US clearly began to affect price – talks going well meant higher oil demand, and prices rose; talks going badly meant lower oil demand, and prices fell.

Meanwhile, the oil market showed signs of tightening towards the end of 2020. Although there was much cheating on the OPEC+ agreement that was trying to restrain production and protect prices, the OPEC meeting last December saw both Iraq and Nigeria agreeing to restrain production.

US stock levels also began to fall in December and the futures markets began to price in a tightening market towards the end of 2020. Significantly, the tighter the market appears, the greater attention is paid to the level of spare producing capacity.

Just before the attack on Abqaiq, the International Energy Agency (IEA) estimated there was 3.5 Mb/d spare capacity in OPEC which, historically, is quite comfortable. However, 2.5 of this was estimated to be in Saudi Arabia, so how much of this spare capacity still existed after the Abqaiq attack?

The Saudis claimed the Abqaiq capacity was quickly restored but technical experts greeted this with considerable skepticism, not least because the Abqaiq equipment was highly specialized. If spare capacity is tight, this makes the oil price vulnerable to geopolitical scares and rumours, real or imagined.

Although the assassination of General Soleimani has exacerbated the sensitivity of oil markets to geopolitical events, this becomes irrelevant if a serious shooting war starts in the region. Saudi Arabia, the UAE and Iraq’s oil infrastructure remains highly vulnerable to attack either directly by Iran or one of its many proxies, suggesting oil prices will become increasingly volatile but, at the same time, benefit from a rising geopolitical premium.

Alleged Military Initiatives in Iran may Impact Oil Prices Further

May. 20 2020 — Drone attacks on pipelines in Saudi Arabia and the mysterious alleged sabotage of tankers near Fujairah sent pulses racing, but a phony war in the Persian Gulf failed to trigger a feared triple-digit surge in crude prices.

A hot war, however, between the US and Iran could be an entirely different matter.

Tehran has repeatedly threatened to shut down the Strait of Hormuz in the event of an outright conflict with America and its Arab allies. The chokepoint is an obvious target. Over 18 million barrels of oil are shipped daily through the 21-mile-wide channel that separates the Islamic Republic from the Arabian Peninsula.

In 2008, worries that Iran would blockade the strait helped to send oil prices skyrocketing to a record $147/b, a level not achieved since.

“A hot war in the Gulf, especially prolonged closure of Hormuz or severe damage to [the giant oil processing facility of] Abqaiq, would send crude prices well into the triple digits,” said Robert McNally, president of Rapidan Energy Group and former advisor to President George Bush.

“That price spike would slam growth, crush oil demand, and trigger an oil price reversal to the low double digits.”

Abqaiq could be the Achilles’ heel of Saudi Arabia’s oil industry.

Located in the kingdom’s eastern province, the facility filters impurities such as sulfur and gas from around 7 million b/d of crude. This is roughly equal to the country’s entire exports and a volume of readily available crude that is impossible to replace easily.

Destroy it and experts fear an uncontrollable panic would grip oil markets and the global economy.

Saudi Arabia’s enemies also know it. Al Qaeda terrorists went for the jugular in 2006, but were unsuccessful in an attack on the plant.

Since then, the Saudi authorities have beefed up their defenses around Abqaiq to fortress-like proportions with what is effectively a private army guarding the facility. In the wake of the Jihadi attack, state-run Aramco insisted Abqaiq was not critical to its operations, but experts still aren’t convinced.

“If the oil market has a beating heart, it is Abqaiq,” warns McNally.

Oil price reaction muted

Despite the growing risks, a conflict in the Gulf region would probably be brief. Neither the US, nor Iran , wants a war. For President Donald Trump, gasoline prices above $3/gal could be ruinous for his reelection campaign and confronting Iran over its nuclear ambitions looks less urgent than his trade problems with China.

Tehran wants a free hand in the Middle East and the ability to sell its oil without US sanctions, but even its most hardline leaders, such as the feared Revolutionary Guard General Qasem Soleimani, cannot seriously believe they would prevail against the world’s most powerful military.

Gulf Arab oil producers have been acutely aware of the vulnerability of the Strait of Hormuz for decades and have intensified their efforts to create new export routes.

In 2020, the UAE opened a 240-mile long pipeline with capacity to pump 1.5 million b/d of crude across the Hajar mountain range to the port of Fujairah and beyond the reach of Iran. The alleged sabotage of tankers near the port this week – which the US suspects Tehran is behind – challenges this strategy.

Meanwhile, Saudi Arabia has stepped up efforts to increase export capacity from its Red Sea coast via pipeline and the opening of a new terminal last year at Yanbu Port with capacity to ship 3 million b/d of crude. However, the drone attack on its 744-mile East-West Pipeline has once again proved how vulnerable its vital oil infrastructure remains. Combined, these incidents give the impression of a region on the brink of war, a risk oil markets have ignored.

Oil prices rose by little more than 1% after the announcement of the Saudi pipeline attack and traded for most of the week around $72/b. If the intention of these attacks was to frighten oil traders into action, it failed.

“This raises real risk of miscalculation, given a more hawkish Trump administration following the departure of Defense Secretary [Jim] Mattis,” said Paul Sheldon, geopolitical risk advisor at S&P Global Platts Analytics.

Spare capacity at risk

It is assumed Saudi Arabia and its partners in OPEC with the help of Russia will come to the aid of markets in times of extreme stress.

S&P Global Platts Analytics expects the grouping – which is holding a technical meeting in Saudi Arabia this weekend – to compensate for lost Iranian barrels as US sanctions against Tehran begin to tighten after the expiry of waivers. However, this will come at the expense of spare capacity. The group’s supply buffer of last resort could fall dangerously low, to 1 million b/d, according to Platts Analytics.

Of course, industrialized consumer economies also have their own crude reserves to fall back on in case of an emergency in the Gulf. The International Energy Agency calls on its 28 members to maintain reserves equal to 90 days’ worth of the previous year’s net-oil imports.

This might be fine if the Strait of Hormuz was the oil market’s only worry, but it’s not. Russia’s three-week long problem with contaminated Urals crude disrupting exports to Europe forced some consumers to release reserves. Meanwhile, Venezuela remains in a constant state of political convulsion along with Libya, which is key to supplying Europe ’s refiners with high-quality crudes .

For now, traders are betting that cool heads will prevail in the Middle East but the odds of a catastrophic mistake occurring are getting shorter.

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