You’d never know it from the oil price, but the global seaborne oil supply might face a 40% cut. In the last few days the Brent Crude price has dropped from $115 to $110 a barrel, where it has spent much of the last three months.
So why could the global oil supply fall by 40% overnight?
Iran has threatened to block the Strait of Hormuz in response to US sanctions.
The Strait of Hormuz is the narrowest part of the Persian Gulf. Oil from producing countries like Saudi Arabia, Qatar, and the United Arab Emirates also ship their oil through the strait. All up, 40% of the oil produced around the world each day goes through this narrow channel.
So what sanctions would trigger Iran to block the Strait?
The US has asked the world to stop buying Iranian oil.
The US has lobbied China and Europe to buy their oil elsewhere. The US stopped buying Iranian oil years ago. China, Spain, Italy and Greece are still big buyers. Iran still makes up 5% of global production.
The US has put the pressure on Iran in this way to get Iran to give up its nuclear ambitions.
This reeks of hypocrisy. How can the US, which has the world’s largest store of nuclear weapons, tell other countries not to develop them? It is also inconsistent. The US let Israel develop its nuclear capacity with minimal interruption.
Iran is not happy being told what to do by a financially and morally bankrupt foreign power. And in response it threatens to close off the Strait, which would cause the oil price to soar.
Oil has a long history of triggering conflicts. There is a great quote in the movie Blood Diamond that puts it well. A villager stands in front of his burning village, with dead bodies scattered everywhere, and says “…let’s hope they don’t find oil. Then we will have REAL problems.”
Because the Strait is an obvious flash point, the US has a strong military presence in the region. The US Navy has a fleet moored off the coast of Dubai. Right now, the US has positioned two aircraft carriers in the Strait, and a third is on its way. Of course, Iran has a powerful military of its own. And while Iraq had few friends, Iran has powerful allies in Russia and China. Conflict needn’t be naval either. Soldiers can launch powerful anti-ship missiles just as easily from small trucks hidden in nearby desert.
Is the US drawing the world back into war?
If you look to the calmly trading oil market for answers, it doesn’t seem likely. Oil prices have been falling, not rising.
And there are a few good reasons for this.
For one thing, the US can’t afford a conflict. Its last two conflicts have cost $1 trillion each. Obama has asked Congress to raise the US debt ceiling (again) by $1.2 trillion to $16.4 trillion. And that’s just to pay for the yawning gap between tax revenues and government expenses.
More importantly, the US knows conflict would lead to oil prices high enough to freeze economic growth in its tracks.
But Iran has rephrased its threat slightly over the weekend. Ahmad Valid, Iran’s defence minister, has back-pedaled and said Iran did not actually say “it will close the strait”.
Making sure everyone understands each other would be a good start.
The US has lobbied China and Europe to drop Iranian oil, but has not made much progress. China doesn’t seem interested. Europe has asked for six months to consider its options. Japan, South Korea and India have said they would only reduce their use. Sanctions are only partly in place.
So far it seems the US has stirred up Iran, without achieving anything.
Quite rightly, the countries that buy oil from Iran would like to know where they could get oil from instead. 5% of global supply is not easy to replace. Saudi Arabia, the world’s largest oil exporter, is confident it can bridge the shortfall. Ali Naomi, Saudi Arabia’s oil minister said, “Whatever customers want, we will give it to them.”
But it is widely believed that Saudi Arabia is already at peak production, and doesn’t have anywhere near the reserves it claims to have. So whether it can bridge the shortfall is to be seen.
Needless to say, this kind of talk has drawn Saudi Arabia into the fray. Iran has said, “Such moves are not considered friendly, and that the consequences…could not be predicted.”
The US would prefer to avoid conflict. But Iran could be unpredictable when backed into a corner. How this will pan out is impossible to say.
It does point to the increasing importance of sourcing energy from less volatile regions, preferably from your own doorstep. For example, the shale gas revolution in the US has given it an entirely new home-grown energy source. Shale gas projects in Australia are having some success as well.
Being self-sufficient will become more important as global tensions build over energy supplies. But it’s not just the Strait of Hormuz that we should focus on.
The South China Sea is a bit closer to home. And it could be a more important flash point. About 30% of the world’s seaborne oil is shipped through the 2 km wide Straits of Malacca (between Singapore and Sumatra), into the South China Sea.
China has been throwing its weight around much more in the last few years, claiming disputed territories and islands.
The US has recently stepped up its footprint in the area. It has promised to divert its military resources to police the region in the 21st century.
This military build-up in our backyard could have big implications for energy stocks in the future. And there will be some highly profitable investing opportunities on the back of it.
Dr. Alex Cowie
Editor, Diggers & Drillers
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Written by Dr. Alex Cowie
Dr Alex Cowie is Money Morning‘s Chief Resources Analyst. (To have his newest investment ideas delivered straight to your inbox you can subscribe to Money Morning for free here).
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