In yesterday’s Money Morning article on global oil supply I wrote to you about the oil crisis brewing in the Straits of Hormuz. This is the narrow channel that runs between Iran and Saudi Arabia. Forty per cent of the world’s sea-borne oil is shipped through here. Iran recently threatened to close the channel in response to a US-led embargo on Iranian oil. Global oil supply could fall 40% if Iran followed through on its threats.
This is not a new story. Iran and the US have been squaring off for 10 years. Not that this means it is a less important story to monitor today.
In the last few days, Saudi Arabia has offered to bridge any shortfall in production. Iran is not happy about this and is warning of ‘unpredictable consequences’ in return.
The Saudis are not worried, and are pushing on.
The Saudi Oil minister, Ali Naimi, just announced a goal to keep oil prices in the region of $100 a barrel. The Saudis are the world’s largest oil exporters. November 2008 was the last time they set a goal, which was $75 a barrel. The oil price increased from $50 to $75 within six months. The price then oscillated around the $75 level for the next 12 months.
There are good reasons for both Iran and the US to avoid a conflict. The oil price certainly hasn’t soared in anticipation of conflict just yet. And if Saudi Arabia’s $100-a-barrel target becomes a reality, then prices will fall, not rise.
That’s not to downplay what might happen here. Far from it. Tempers are rising, Iran is unpredictable, and it has some powerful allies, such as China. In some ways, this is an indirect power game between the US, which is controlling Iran’s oil supply, and China, which buys Iran’s oil.
I think what is happening in the Strait of Malacca may become more important than the Straits of Hormuz in coming years.
The Strait of Malacca is the shipping channel between Singapore and Sumatra. Ships carry around 14 million barrels of oil a day through this strait, which is not far behind the 17 million that move through Hormuz each day.
It is the shipping gateway to the South China Sea, which then joins the Pacific. At just 2 kilometres wide in places, 60,000 ships each year pass through the Strait – or one ship every 10 minutes. It has been a magnet for pirates in the past and is now heavily policed. The Strait of Malacca is the Achilles Heel for Asia’s oil supply.
You get an idea of why the gateway to the South China Sea is so important when you consider just how many people live in the region. Above the South China Sea you have 1300 million people living in China. To the east you have 100 million people in the Phillipines. In the south, 240 million people live in Indonesia. Then to the west, 200 million people are spread across Thailand, Vietnam, Cambodia, Laos and Malaysia. Let’s not forget there’s also 70 million people in Taiwan and South Korea.
All together, that is close to 2 billion people.
All clustered around a sea the size of Western Australia.
You can see why the South China Sea’s shipping channels are getting a bit busy. Particularly when you consider that most of the countries are in earlier stages of industrialisation: this is the period in an economy’s life that consumes the most resources.
To make things complicated, there is plenty of disagreement over who controls what parts of the Sea. China lays claim to most of the region. Vietnam’s claims overlie large swathes of China’s claims. China’s claims also cross over most of what the Philippines claims to own. Then Vietnam’s claims also overlie the Philippines’!
The disputed claims over the South China Sea are thought to be Asia’s most likely flashpoint for conflict. There have been scuffles between China and Vietnam in the past. But it’s amazing that there hasn’t been serious conflict more recently.
You see, the South China Sea is also resource rich. It holds rich oil and gas fields. Some are in disputed waters, such as the Malampaya and Camago gas fields. It is also host to valuable fisheries. And, of course, the all-important shipping lanes.
With such valuable resources in the Sea, China has been flexing its military muscle recently in the region. Vietnam and the Philippines claim that its vessels involved in oil exploration and fishing have been harassed in recent months. A Chinese military commander quoted in a newspaper reminded its neighbours that ‘China is a big country, and its neighbours are small’.
Last year, US Secretary of State Hillary Clinton asked China to sort out the territorial disputes. China told Hillary to keep her nose out of it. Since then Obama has pledged to move more US military resources into the region, and has pledged to strengthen its presence. One of its first moves was to start deploying 2500 US Marines right here in Australia.
So the recipe for South China Sea stew looks very spicy. With 2 billion people crowded around a pond, some of the busiest shipping ways in the world, overlapping claims and a belligerent China bullying its neighbours. Now enter Team America to save the day.
This story is still brewing. But this could disrupt shipping channels in the future. And that would throw the oil market into chaos.
The Iran story will put a growing premium on energy production in low-risk regions, such as Australia. But I think what is happening in our own backyard, in the South China Sea, will have a greater impact on the value of Australian energy companies in the future.
Dr Alex Cowie,
Editor, Diggers & Drillers
[Ed Note: Leading US energy analyst Dr Kent Moor gives his insight in today's other article on Iran oil and the brewing Straits of Hormuz crisis...and the direction of the oil price.]
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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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