Strait of Hormuz | Tension in a Key Crude Oil Chokepoint

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Much like other vital commodities in the world economy, the price of crude oil is subject to pressures from a range of factors, including infrastructure, supply and demand economics, and global geopolitics. The latter of these, however, has an increasingly critical role in crude oil transportation dynamics. Trade agreements between countries can create new transport routes for the commodity with a simple handshake, while land disputes or ideological differences between nations can rupture these relationships and reshuffle the energy marketplace – driving oil prices lower or higher in the process.

With the United States’ decision to end sanction waivers for imports of Iranian energy products, the spotlight has again returned to political tension in the Middle East. Iran must now confront lesser demand for its exports, while neighboring nations reevaluate production dynamics to prevent shortages in global oil supply. This tension has recently intensified, as two Saudi Arabian oil tankers in the Persian Gulf were attacked in early May, allegedly by forces connected to Iran. With the attacks occurring near the Strait of Hormuz, crude prices rose as investors began to fear the conflict would disrupt crude transportation in one of the world’s most important maritime chokepoints.

What Are Maritime Crude Oil Chokepoints?

With more than half of the world’s crude oil production moved via ship, disruptions to maritime transport can have very direct and nearly immediate implications for crude prices. These events are especially impactful when they involve the world’s major maritime chokepoints, or narrow channels in longer trade lanes that limit both the size and number of vessels that may pass through their waters.

Often, these chokepoints are beneficial to vessels as they typically shorten journey length– the Panama Canal, for example – saving time and money. The image below demonstrates how these areas open global trade further between the U.S., Europe, Africa, and Asia. Chokepoints present a significant risk, however, when they are the only entry or exit point for vessels in a particular region.

(Source: U.S. Energy Information Association)

Why is the Strait of Hormuz Important to Global Oil Trade?

The Strait of Hormuz is a key example of this potential risk. Located between Oman and Iran, the Strait of Hormuz links the Gulf of Oman with the Persian Gulf. All crude vessels seeking to transport crude product from the region must pass through its waters. Although the Strait is still 21 miles wide at its most narrow point, the only location with sufficient depth for tankers to pass through lies in a two-mile-wide corridor at its center.

The unavoidability of the strait for transporters of crude oil further contributes to its strategic importance for members of the Organization of the Petroleum Exporting Countries (OPEC). Many key members of the organization, including Saudi Arabia, Iran, the UAE, Kuwait, Qatar, Bahrain and Iraq rely on it for their crude exports. According to the U.S. Energy Information Association, nearly one-third of global crude oil traded by sea must pass through the Strait of Hormuz, with just under 20 million barrels per day passing through the waterway in 2016.

While it is possible for some of these countries to bypass the strait via pipeline to export crude, the capacity within these operations is insufficient for a large portion of total crude production. The chart below illustrates the three largest pipeline operations, with the East-West Pipeline in Saudi Arabia offering the largest capacity at 4.8 million barrels of oil per day (mmbd), and the Habshan-Fujairah and Abqaiq Pipelines following at 1.5 and 0.35 mmbd respectively. The recently-completed Habshan-Fujairah Pipeline was specifically designed to avoid the Strait of Hormuz by connecting western oil fields with the Gulf of Oman, a move other countries in the region may consider should tensions continue to rise.

How Does the Market Respond to Conflict in the Strait of Hormuz?

Tensions have flared in rhetoric surrounding the Strait of Hormuz several times in recent history. Threats to close the strait and other disruptions occurred in the 1980’s during the Iran-Iraq War, in the early 2010’s surrounding discussions to curb Iran’s nuclear program, and more recently after the U.S. withdrawal from the Iran nuclear deal.

While markets typically respond to threats to close the strait by demonstrating upward price pressure, the longevity of this response is highly variable. Following the U.S. exit from the Iran Nuclear Accord in May of 2018, oil prices rose throughout the month. Later, in December, Iran’s most recent official threat to close the Strait of Hormuz had little impact on crude price, as other production dynamics contributed to the overarching trend of falling energy product prices to close 2018.

Although threats to close the Strait of Hormuz continue to surface, several considerations have prevented a block or closure from coming to fruition. Because crude production is central to the economies of the OPEC-member nations surrounding the Persian Gulf, any major disruption to export transportation would negatively impact even the instigator’s capacity to sell. Additionally, the presence of the U.S. Fifth Fleet in Bahrain may also deter the realization of a blockage.

While ambiguity lingers about how removal of Iran’s oil exports will affect the global energy marketplace, and tension simmers in the Middle East, the Strait of Hormuz will likely remain in focus as affected nations negotiate these changing dynamics. Crude oil transportation through this strait as well as other major global chokepoints will continue serve as a proving ground for geopolitical negotiations.  Ahead of their semi-annual meeting in June, members of OPEC and other major producers recently announced they will continue to monitor supply outcomes from Iranian sanctions and other geopolitical and economic factors – a statement that itself reflects the continued market uncertainty that lies ahead.

 

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