The premium appears to be creeping back into international oil prices as markets wait to see who will be policing the sea lanes in the aftermath of a Saudi announcement that it would temporarily halt oil shipments via the Bab el-Mandeb Strait. The Saudi announcement came after two of its oil-laden tankers were attacked by Yemeni Houthi militias. Shipments in the Bab el-Mandeb Strait, which connects the Red Sea and Suez Canal with the Persian Gulf and Indian Ocean via the Gulf of Aden, is a major sea route for oil shipments of close to five million barrels a day (b/d) of crude oil and petroleum products in both directions, including 2.8 million b/d flowing from the Mideast to Europe. Refined products from Saudi Arabia’s Yanbu refinery on the Red Sea are frequently exported south through the Bab el-Mandeb Strait to Asia. The Strait can be bypassed for northern traffic by sending ships on a longer, more expensive route around the southern tip of Africa.
Yemeni rebel attacks on shipping in the Bab el-Mandeb Strait are not a new occurrence but take on new importance in light of the U.S. withdrawal from the Iran nuclear deal (JCPOA) and subsequent planned reimposition of sanctions against Iranian oil sales. Iran has threatened that the United States would be mistaken if it thinks Iran would be the “only” country unable to export its oil. Iran explicitly mentioned its ability to close the Strait of Hormuz through which over eighteen to nineteen million b/d of Mideast crude oil transits. The United States has the capability to reopen any blockage of the Strait by military means and provided minesweepers and military shipping escorts to reflagged Kuwaiti oil tankers in the 1980s during the eight year Iraq-Iran war.
Saudi news outlets have run headlines in recent days that the United States was “weighing” its military options to keep the sea lanes open. The headlines, also published in Israeli newspapers, are referring to a statement made by U.S. Defense Secretary James Mattis who told Pentagon reporters on July 27 in discussing Iran’s threats to a different waterway chokepoint, the Strait of Hormuz, “They’ve (Iran) done that in years past; they saw the international community put dozens of nations’ naval forces in for exercises to clear the strait…Clearly this (closure) would be an attack on international shipping and could have an international response to reopen the shipping lanes…because the world’s economy depends on those energy supplies flowing out of there.” Mattis called upon Iran to abide by international rules.
Analysts say the U.S. withdrawal from the JCPOA has strengthened unity and coherence of the various factions within the Iranian government, moving Iranian President Hassan Rouhani to the right. Thinking about succession down the road for aging Supreme leader Ayatollah Ali Khamenei is influencing how the current line-up of political and religious leaders inside Iran are responding to the country’s current problems, Iran watchers say.
Still, in private briefings, Iranian officials are throwing around the term “strategic patience” as a guide to current thinking and noting that Iran has weathered sanctions for decades and will take no drastic measures against the United States or its regional allies. The argument goes that Tehran can afford to wait out the Trump administration, which will face a new election in 2020, and that Iran’s priority in the interim should be to avoid direct military clashes with the United States—which it believes U.S. allies Saudi Arabia and Israel would like to provoke. That raises the question regarding how much control Tehran has over its many armed proxies in Iraq, Yemen, Syria, and Lebanon. The relative independence of such proxies increases the risk of unintended or inadvertent clashes across a range of flash points, complicating U.S. responses.
In the intervening years since the Iraq-Iran war, several Arab oil exporters have built oil pipeline bypass routes so that a portion of their crude oil exports could avoid the Strait of Hormuz. Saudi Arabia’s Petroline, which can carry five million b/d of Saudi crude oil from eastern fields to an export facility on the Red Sea, is being expanded to carry seven million b/d by year end. Use of drag reduction agents can augment flows by as much as 65 percent. Abu Dhabi also has a 1.5 million b/d crude oil pipeline from Habshan to Fujairah that bypasses the Strait. Oman is building an oil storage hub at Duqm, and several Gulf Arab producers keep floating oil storage in tankers off the coast of Fujairah. Industry estimates are that Saudi Arabia also has over seventy million barrels in operational and strategic storage in Asia and Europe, among other locations.
Saudi leaders have been hoping that a military victory at Yemen’s port of Hodeidah might pave the way for intervention by the United Nations, progress on diplomatic negotiations, and by extension, a reduction in the risk to shipping in the Red Sea. So far, this goal has not been reached; hence, headlines in official news outlets about the U.S. role in the sea lanes.
President Donald Trump has actively tweeted about oil prices in recent weeks including a tweet that specifically mentioned how the United States protects regional countries. More recently, Presidential tweets have included warnings to Iran not to “threaten the United States.” The United States plays a critical role defending the global sea lanes and ensuring the free flow of oil around the world. Yemeni attacks on Saudi shipping make it harder for oil prices to recede, and saber rattling between Iran and the United States is on the rise as the November oil sanctions deadline approaches. This geopolitical backdrop is currently keeping oil markets on edge, despite increases in supply.
As U.S. midterm elections approach, high oil prices might not be the only factor that enters voters’ minds as they prepare to vote. The American public is weary of costly military engagement across the Middle East and could wonder why the United States is so unable to extricate itself from its role defending Middle East oil shipments, especially in light of rising U.S. domestic oil and gas production. Less than 10 percent of U.S. oil imports came from Saudi Arabia in 2017, with an additional 600,000 b/d originating from Iraq. But, Saudi Arabia remains a major oil supplier globally and most of the world’s spare oil production/export capacity sits in Saudi Arabia, Kuwait, and the United Arab Emirates. That means any disruption of oil supplies in the Persian Gulf would be a major threat to the global economy and would hurt U.S. trading partners, thereby damaging the U.S. economy as well even if the United States could more easily replace its limited Saudi and Iraqi oil imports. Hence, U.S. oil and gas production and exports have not reduced the U.S. need to police the free flow of oil from the Middle East. Oil commodity prices are also set globally which means like a swimming pool, where taking out water in one end of the pool affects the water level across the entire structure, an oil price rise due to the loss of supply in one part of the world is reflected in U.S. price levels as well all other locations across the globe. Rising oil prices still put U.S. consumers and important industries like the automotive sector under pressure, even if they are less negative for the overall U.S. economy.
Ironically, the more successful the United States is in convincing the major economies to shun Iranian crude oil purchases, the more it could need to talk to the very same countries about sharing the financial or military burden of defending the sea lanes for oil flows from the Middle East. Without taking such action, it will be hard to convince Iran or its proxies that it is counterproductive to escalate threats to international shipping. Although the United States has appeared to shun international cooperation of late, continuing to maintain a very broad the coalition of European and Asian countries in sea lane navigation matters could discourage risky brinksmanship activities by all parties that could benefit from a direct confrontation between the United States and Iran.