Markets ignore the dangers of a Middle East oil rift at their peril
Saudi Arabia’s decision to temporarily suspend its oil tankers entering the Red Sea is a shock for energy markets but prices have hardly budged. The surprise move follows repeated attacks by militants from Yemen on the country’s giant crude-carrying vessels entering the waterway. In a volatile region like the Middle East, ignoring the risks to oil tanker traffic looks reckless.
Almost 5m barrels of crude and refined petroleum products are shipped daily through the Bab el-mandeb Strait into the Red Sea, where a large proportion are unloaded at the Egyptian port of Ain Sukhna.
From there, around 1.5m barrels per day make their way into the Mediterranean and thirsty European markets through the Sumed pipeline, which provides the bulk of the region’s vital crude imports.
Saudi Aramco – the world’s largest exporter of crude – said last week it had halted all shipments through the Bab el-mandeb Strait following an attack by Houthi militia from Yemen on two of the kingdom’s giant tankers.
No other shipping using the route is affected but the state-owned company’s caution is understandable. The vessels, known as “very large crude carriers”, can transport 2m barrels of oil in a single loading.
The kingdom ships about 10pc of its total crude exports to Europe through the Red Sea. Saudi Arabia’s exports in June averaged around 7.5m barrels per day, according to S&P Global Platts estimates.
Despite the risks, oil prices have delivered a muted response to the growing geopolitical issues in the Middle East, with crude currently trading just below $75 per barrel.
Of course, it’s easy for markets to dismiss these events as purely sabre rattling and scaremongering. Despite the fraught politics of the region, disruptions to its constant stream of crude powering the global economy have been extremely rare.
However remote the possibility is of poorly armed Houthi fighters sinking one of these ocean-going giants, such an incident would cause an environmental disaster and probably trigger an economically ruinous surge in oil prices. This explains Saudi Arabia’s decision to temporarily suspend its shipments in the area “in the interest of safety of ships and their crews, and to avoid the risk of an oil spill”.
It’s not the first time Houthis have targeted Saudi oil shipments in the area, which at its narrowest point separates the Horn of Africa from the coast of Yemen by just
18 miles of water.
In April, Houthis attacked the Saudi oil tanker called Abqaiq in the southern Red Sea. Pictures of the vessel, which was carrying 2m barrels of crude, showed damage to its thick-skinned double hull caused by the attack. Although the Houthis are unlikely to want to escalate matters by sinking a vessel, their actions are increasingly worrisome.
Without access to the Red Sea through the Bab el-mandeb Strait, Saudi’s options to get its crude into European markets are somewhat limited. The kingdom has a giant pipeline crossing Arabia, which is capable of taking crude from its Eastern Province oilfields to the port of Yanbu on its Red Sea coast, but the link’s capacity is constrained. Other alternatives would be shipping oil into Europe via the much longer trade route around the Cape of Good Hope.
“The Saudi move will likely force tankers on a longer trip around Africa,” said Paul Sheldon, chief geopolitical adviser at S&P Global Platts Analytics.
“It should boost Med barrels, and could eventually raise Brent and other grades due to the higher requirement for volumes at sea. Until now, Houthi attacks on Saudi targets have been largely unsuccessful, but remain an under-reported security risk in the world’s largest oil-producing region. Neither Saudi Arabia nor Iran want a hot war, but Iran views Yemen as a low-cost way to bleed its Saudi rivals.”
The latest attack comes as the war of words between the US and Iran over the security of oil supplies from the Persian Gulf heats up. Faced with tough sanctions, which could prevent Iran exporting 1m b/d of crude, Tehran has threatened to prevent its Gulf Arab
‘In a volatile region like the Middle East, ignoring the risks to oil tanker traffic looks reckless’
neighbours and close US allies from making shipments from the region. US President Donald Trump has fired back on Twitter, warning Iran there could be consequences from taking on the world’s largest superpower.
Neither is Bab el-mandeb the only choke point under threat. The Strait of Hormuz, which separates Arabia from Iran, is used to ship about a fifth of the world’s crude. Although heavily protected by the US navy, the conduit remains vulnerable.
Iranian threats to the waterway could intensify as the deadline for US sanctions hitting the Islamic republic’s crude exports in November draws nearer.
“The real risk of miscalculation is now significantly higher,” said Ehsan Khoman, head of research and Middle East strategist at MUFG Bank.
“Threatening strait closure mounts pressure on the US to find a diplomatic solution, due to the uncertainty a Us-iran confrontation would invoke. From Iran’s perspective, given the large number of importing countries that rely on oil delivered from the Strait of Hormuz, Iran can construct a hindering narrative that demonstrates that the US is generating a geopolitical crisis that is globally unfavourable.”
Meanwhile, the risk premium attached to oil is rising. Supported by Iran, Houthi militants are intensifying their strikes on oil targets in the kingdom and beyond.
These attacks could escalate as the war in Yemen, led by Saudi Arabia, drags on and the US sanctions on Tehran snap into place.
“I think oil’s risk premium will rise when the sanctions snap back,” said Helima Croft, global head of commodity strategy at RBC Capital Markets.
“Not only will the market have to contend with more maritime incidents – particularly related to the Yemen proxy conflict – but also an Iranian nuclear restart. Given that the terms being offered by the Trump administration essentially amount to a call for capitulation, I do not see a readily available path to de-escalation. I am not sure the market appreciates that a miscalculation could bring us to the brink of a war.”
Although a repeat of the tanker war, which hit oil shipping in the Middle East during the early Eighties, isn’t predicted, the chance of a major escalation in the region affecting crude markets is rising. It’s a danger that cannot be disregarded any more.
Andy Critchlow is head of energy news for EMEA at S&P Global Platts