How Iran Can Hold the World Oil Market Hostage

Workers at the damaged site of Saudi Aramco oil facility in Khurais, Saudi Arabia, September 20, 2019. Hamad l Mohammed/Reuters

Iran poses an acute threat to oil infrastructure across the Middle East, potentially allowing it to extort concessions from world powers.    

Last updated October 29, 2019

Workers at the damaged site of Saudi Aramco oil facility in Khurais, Saudi Arabia, September 20, 2019. Hamad l Mohammed/Reuters
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Current political and economic issues succinctly explained.

Oil remains central to the global economy and security architecture. Even as the world aspires to confront climate change and curb its appetite for fossil fuels, it continues to depend heavily on oil to power its cars, trucks, tanks, jets, and ships.

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The debilitating attacks on Saudi Arabia’s oil industry last month, which the United States has attributed to Iran, were a reminder of the fragility of the oil market, and how certain world actors such as Iran may attempt to use this to their geopolitical advantage. Iran and its proxies could hold major oil facilities in the Middle East hostage, threatening to destroy them if their demands are not met.

What is Iran’s threat to oil infrastructure in the Middle East?

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Oil and Petroleum Products

Iran

Saudi Arabia

Yemen

Missile Defense

In recent years, Iran has built up an arsenal of thousands of missiles, including cruise and ballistic missiles, capable of doing severe damage to oil facilities across the Persian Gulf. It also has troops and proxy fighters with missile, rocket, and drone capabilities scattered across the region: in Iraq, Lebanon, Syria, and Yemen.

How vulnerable are oil installations?

Some U.S. missile defense systems, such as the Patriot system, can theoretically defend a specific base or facility, while others, like the Terminal High Altitude Air Defense (THAAD) system, can protect a broad area. However, Iran can attack regional oil installations from multiple fronts using a variety of weapons, including drones and cyberattacks. Thus, it is extremely difficult to protect all facilities of all regional producers simultaneously, particularly in Saudi Arabia, where the oil industry has a large geographic footprint.

Recent media reports have said that Saudi Arabia is particularly vulnerable to inexpensively made armed drones, which have successfully evaded the kingdom’s existing air defenses. Iran-backed Houthi rebels in neighboring Yemen have used these weapons to target critical sites in Saudi Arabia, including airports and oil facilities.    

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How disruptive can an attack be?

A well-targeted strike can be crippling. The coordinated attacks on the Abqaiq crude processing center and the Khurais oil field last month disrupted the production of about 5.7 million barrels per day, or about 5 percent of the global supply. It was the largest such hit to oil production in history.

Chart showing largest disruptions to world oil supply in history.

Fortunately, the Saudi oil industry has rebounded quickly because of its relative size, redundancy, and spare field capacity, but additional attacks could chip away at this resiliency, delaying repairs and bypasses. Sites such as Abqaiq are particularly vulnerable because of their large concentration of vital equipment within range of some of Iran’s pre-positioned missile batteries. Further damage to Abqaiq could once again pull millions of barrels of Saudi crude offline daily, perhaps for a long period of time. Similar facilities could be attacked in southern Iraq, Kuwait, or the United Arab Emirates (UAE).

More on:

Oil and Petroleum Products

Iran

Saudi Arabia

Yemen

Missile Defense

How are markets pricing these risks?

Oil is a global commodity, so its pricing is determined by global supply and demand. If the oil market loses Saudi or Iranian oil, prices rise for users worldwide, not just users of Saudi or Iranian oil.

International oil prices jumped by 20 percent in one day following the attacks on Saudi Arabia, but they have since receded with the expectation that the facilities will be repaired, and that, because the global economy is slowing, the world’s oil use will fall.

With oil currently trading at under $60 per barrel, it seems the market is not yet accounting for these real risks.

With regard to Iran, traders appear hopeful that diplomatic efforts will prevent Iran from launching a second, more painful attack. They believe that Iran’s attacks on Saudi facilities thus far have been a warning to gain leverage for negotiations toward sanctions relief or removal. Rightly or wrongly, traders seem to be downplaying the risk that Iran will conduct more heavily disruptive strikes to get sanctions lifted, or that, somewhere down the road, Iran could launch major attacks on oil infrastructure to obtain some other foreign policy objective.

However, given the region’s past unrest and ongoing tensions, it’s not unreasonable to think that future attacks by Iran or its proxies could trigger a wider conflict in which oil facilities suffer extensive damage. During the eight-year-long Iran-Iraq war, both countries saw their oil industries decimated, removing their production capability from markets for many years. Iraq’s invasion of Kuwait in 1990 resulted in the immediate loss of millions of barrels per day of oil. A prolonged regional war with Iran could potentially see damage of more than ten million barrels per day, which could take years to repair.

With oil currently trading at under $60 per barrel, it seems the market is not yet accounting for these real risks.

Is the United States dependent on foreign oil?

The United States remains a net crude oil importer—gross crude imports totaled seven million barrels per day in July 2019—and it is only slightly less exposed to an oil shock today compared with 1973, when Arab members of the Organization of the Petroleum Exporting Countries (OPEC) imposed an embargo in retaliation for U.S. military support for Israel. The rebound in U.S. crude oil production over the last decade or so, while helpful, has not rendered the country immune to oil blackmail. Net imports of oil are about 20 percent of U.S. consumption, compared to 32 percent in 1973.

If prices were to spike significantly in the wake of another major attack in the Middle East, U.S. domestic production would likely ramp up, but bottlenecks in hiring additional workers and commissioning drilling equipment, among other logistical obstacles, could cause delays. The time lag could unsettle markets if the disruption lasts longer than a month or two.

In the case of a major crisis—one that removes millions of barrels per day in production for an extended period—it would likely take the United States several years to increase its production to replace fully the lost oil. In the meantime, high gasoline prices would likely dampen consumer spending and slow U.S. manufacturing and other exports, particularly to countries that are hit harder by higher oil prices, such as China and India.

The good news is that the United States is more resilient to an oil price shock than it was in 1973.

The good news is that the United States is more resilient to an oil price shock than it was in 1973. The oil intensity of the U.S. economy—the amount of oil per unit of gross domestic product—is much lower now than in 1973, when more oil was used in manufacturing, power generation, and home heating. Many industries have shifted to natural gas or renewable energies, and virtually no oil is used in U.S. power generation. Additionally, U.S. domestic oil production is distributed more widely across the country now than in 1973. The U.S. shale boom has created jobs and wealth not only in traditional oil states, such as Alaska, Louisiana, Oklahoma, and Texas, but in others too, such as Colorado, North Dakota, Ohio, Pennsylvania, and Wyoming. Many states benefit from high oil prices.

What about other countries’ dependence on oil?

Oil represents about one-third of all energy used globally. It is the dominant fuel for transportation, used almost exclusively for aviation and for most of the world’s automobiles.

Oil demand in Europe peaked in 2005, but its economies remain highly dependent on oil imports, which make up more than 85 percent of the region’s oil use. Europe gets about one-third of its oil supply from Russia. Japan has no domestic source of oil, and is highly dependent on crude oil imports from the Middle East. China’s crude oil imports have been rising in recent years, reaching 10.6 million barrels per day in 2019, making up between 80 and 85 percent of its oil use.

How much of a cushion would the U.S. Strategic Petroleum Reserve (SPR) provide in the case of a major shortage of oil?

The SPR was created in the aftermath of the 1973 oil embargo, which highlighted how a major energy disruption could undermine the economy and threaten national security. SPR oil is intended to provide a backup supply to U.S. refineries, helping the United States weather an unexpected energy crisis, and free it from possible blackmail by petrostates. Presidents have authorized major emergency releases from the SPR three times: during the Gulf War (1991), after Hurricane Katrina (2005), and when Libyan strongman Muammar al-Qaddafi fell from power (2011). The SPR currently holds more than 600 million barrels of crude oil, and it can release at the rate of 4.4 million barrels per day for a period of time.

The United States is also part of the International Energy Agency’s emergency stockpiling system, which covers Western industrialized economies. China and India also hold strategic stocks.

The SPR and IEA stockpiling system have limitations in that it is designed to tide markets over for ninety days. At the time the IEA system was created, it was assumed that an embargo could easily be resolved diplomatically in that amount of time. But if a war were to destroy production capacity at complex oil facilities throughout the Middle East, oil availability could be affected for a much longer period. In this case, oil-consuming nations would need to invoke conservation measures, such as increased energy efficiency and fuel rationing.

How much leverage does this give Iran?

Iran’s ability to destroy critical energy infrastructure in the Middle East gives it some leverage to blackmail the United States, its allies, and other major economies such as China and India. The attack on Saudi Arabia’s oil facilities makes this a credible threat.

Right now, Iran may only be demanding relief from U.S. sanctions, but it could use the oil bargaining chip in pursuit of other national objectives in the future.

Presumably, Iran would only try to use this form of blackmail to achieve concessions it believes to be realistic and in proportion to the threat it actually poses to oil supplies. It wouldn’t be possible, for instance, to try to compel the United States to remove its nuclear weapons from Turkey. But Tehran could, in theory, try to coax Washington to withdraw troops from a certain area or cut military aid to a particular country, as Saudi Arabia attempted to do in 1973.

What are the major obstacles to diplomacy?

The Middle East continues to suffer from conflicts and long-running disputes that complicate decision-making. There are wars in Syria and Yemen, and the unresolved conflict between Israel and the Palestinians could easily spread to militarized zones in Lebanon. Amid this instability, regional actors, including Iran, have little incentive to demilitarize.

It is often assumed that a cease-fire in Yemen would de-escalate conflicts between Iran and Saudi Arabia, but that hypothesis may prove to be oversimplified. Iran’s ambitions in the region, its social and religious alliances, and its petro-power rivalry with Saudi Arabia all predated the Yemen conflict. The role Kuwait, Saudi Arabia, and the UAE played in bankrolling Iraq’s 1979 invasion of Iran, which led to the deaths of hundreds of thousands of Iranians, also influences the contours of regional diplomatic engagements.

However, the Iranian people have been worn thin from economic hardship and war, and that leaves open the possibility of a diplomatic solution that would restore prosperity—once seen as a possible outcome of the Iran nuclear agreement. But given the spotty history of the nuclear deal and the higher level of mistrust today, economic benefits and military concessions on all sides would likely need to be more immediate and more robust than in 2015, making success all the more difficult. Moreover, unrest in many other parts of the world, trade conflicts, and other foreign policy priorities may distract major powers from a focusing on diplomacy with Iran.

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