Cashing in on conflict

A rise in oil prices will cause many frowns and a few smiles

Executive Special Report

The oil crisis in 1973 saw oil prices quadruple, equivalent today to a jump from $125 to $500 per barrel at late February prices. If Iran is attacked and oil tanker traffic is disrupted through the Strait of Hormuz, some 17 million barrels per day (bpd) would be taken off line and the markets would immediately react. Analysts forecast a price spike anywhere from a third (to more than $166 per barrel) to a 100 percent surge (to $250) depending on the scale and length of the conflict.

But what needs to be taken into consideration is current global production, as the markets have been skittish of late. The extent of the markets’ jitters was reflected when the European Union announced oil sanctions on Iran — not implementing them — causing oil prices to rise, to $110 a barrel in January and gained some 15 percent throughout last month on the back of rising tensions. And with the EU having to re-source 600,000 bpd, this has had an effect on the markets. As the United States’ Energy Information Administration (EIA) noted in its monthly Oil Market Report in February, “International sanctions targeting Iran’s existing oil exports do not come into effect until July 1, but they are already having an impact on crude trade flows in Europe, Asia and the Middle East.”

Add to this that Europe no longer has access to around 145,000 bpd it imported from Syria due to last year’s sanctions, and post-Gaddafi Libya is still not at full operating capacity, pumping some 300,000 bpd less than the 1.6 million bpd pumped before the civil war. Equally, instability and attacks on pipelines in Yemen has seen oil production drop by 40 percent over the past few years, from 286,000 bpd in 2009 to an average of 170,000 bpd last year. To boot, the Republic of South Sudan stopped all oil production and exports in late January over a dispute over oil transit fees with its northern neighbor that is not likely to be resolved anytime soon. In total that already amounts to 911,000 bpd off the market.

“I think if the situation in Sudan continues, the more effect this will have internationally,” said Marc Mercer, an East Africa specialist at risk consultancy Eurasia Group in London. “350,000 barrels off the market is not big enough to have a huge shock on the market at the moment; having said that, from the Chinese perspective, 5 percent of their oil comes from Sudan.”

Indeed, if Iranian and Gulf oil also went offline, China would be in a serious quandary, with the Gulf providing just under half of its crude oil imports, as would Japan, South Korea and India, with the Asian markets accounting for roughly three-quarters of the Gulf’s crude exports.

The big picture issue in the advent of a war with Iran is how will 20 percent of the world’s oil production, as well as natural gas, be distributed? Of the 21.45 million bpd produced in the Gulf, 4.45 million bpd is consumed domestically and 17 million bpd is exported. An estimated 5 million bpd could be exported via Saudi Arabia’s Petroline pipeline from the east to Yanbu on the Red Sea, leaving some 12 million bpd under threat. The Trans-Arabian Pipeline, which ran to Lebanon, has not been operational for decades.

One option is the 1.5 million bpd, 370-kilometer-long Abu Dhabi Crude Oil Pipeline that runs from the Habshan oilfields in the west of the UAE to Fujairah outside the Strait of Hormuz, but the pipeline is not yet operational due to delays and is not expected to be functional until the summer. This leaves few options for the remaining oil other than to linger in storage.

The Saudi save?

The world’s swing producer, Saudi Arabia, has promised to boost capacity to help offset demand, although it remains to be seen how the Saudis could export such increased output in the advent of a Gulf conflict, given the kingdom’s lack of transparency when it comes to actual production output. An added complication is that the bulk of Saudi exports go to Asia, meaning oil transported to the Red Sea would then have to head east again, adding on 1,200 nautical miles and five days to shipping times.

What would close the supply gap would be the stock piles amassed by Organization for Economic Cooperation and Development (OECD) governments, equivalent to 1.6 billion barrels, enough to cover the loss of 11.5 million bpd for four and a half months, according to the Center for Global Energy Studies’ publication Global Oil Insight.

According to research carried out by a major Gulf bank, which asked for anonymity, a two-week shut down of the Strait would result in a 25 percent loss in oil trade, causing revenue losses to GCC countries of some $5 billion. After a month, it would lead to a 50 percent loss in oil trade, equivalent to $10 billion. “Based on our assumptions, the impacts wouldn't be very dramatic as it is not realistic for Iran to block the Strait even if they mined it, so two weeks seems to be a reasonable estimate,” said an high-ranking economic analyst at the bank.

But this is perhaps rather a conservative estimate, or “best case scenario.” With an average of 14 tankers a day passing through the Strait, each carrying an estimated $200 million worth of fuel on board, that would be around $2.8 billion worth of oil (at market prices) off the market. Another reading is that the GCC countries earned $465 billion in oil revenues in 2011, equivalent to $1.27 billion a day, although that includes non-sea exports and domestic sales. Therefore, in a worse case scenario, GCC countries could lose more than a $1 billion a day in oil revenues.

Liquefied natural gas (LNG) is another story. Qatar is now the global hub of LNG, accounting for roughly a third of production at 77 million tons per annum, while Abu Dhabi produces 6 million. With the Strait blocked, LNG would be locked in as the primary export route is by sea. Indeed, Qatar’s Ras Laffan Port loaded 1,000 LNG tankers last year, equivalent to 2.7 tankers per day. If LNG exports were blocked, it would be a devastating blow for India, which receives nearly 90 percent of its LNG from Qatar, as well as for other Asian countries, while Italy receives 10 percent of its annual gas needs from Qatar, and Britain 15 percent. Needless to say, a temporary shut down of LNG would be a serious hit to Qatar, which earned $30 billion last year from gas exports. “Of all the Gulf countries I think Qatar is the most worried about a conflict as, theoretically, they would face the chilling prospect of all LNG being undeliverable unless it could be transported to Oman or the UAE, where it could be re-shipped, but I don't think these countries have the re-liquefaction capabilities,” said the analyst.

The good side of bad

But not everyone holds that a war with Iran would be bad. “It wouldn’t affect us at all, as we will be getting $200 a barrel. The Fujairah pipeline could be opened faster and the UAE is always lucky when we face problems,” said a spokesperson for the Abu Dhabi National Oil Company. This would hold true after the crisis ends. According to research by the International Bank of Qatar (IBQ), for every $1 increase in oil prices, the GCC earns an extra $4.5 billion.

“If oil prices shift upwards due to the conflict, the loss of volume (incurred) could be offset (afterwards) by the sale of oil at high prices,” said the economic analyst. Oil producing countries outside of the Gulf would also stand to gain significantly from the price spike. “If oil prices go up, the Russians for instance would benefit hugely as their cost of extraction is much higher than in the Middle East, so would end up making higher margins,” said Michael Elleman, senior fellow for regional security cooperation at the International Institute for Strategic Studies-Middle East in Bahrain.

And while logic would dictate that international oil companies (IOCs) would stand to lose out during a conflict, with operations curtailed and production affected, they would in fact reap profits. “IOCs are happy to have war,” said Anna Abrahamian, an independent energy lawyer. “Certainly insurance fees would go up, but the profits they would make would exceed the risk. That is why when the US pushed for sanctions on Iran no IOCs objected, and there are some companies that have scenarios for making money during sanctions or if a pipeline is blown up somewhere.” She added: “IOCs are praying to go into Iran.”