EDITOR: | January 7th, 2016

Prepare for, rather than predict, future events in the world of oil…

| January 07, 2016 | No Comments

Most commentators are predicting a continued low oil price for the next year at least. This assumes all other things being equal. One of the key assumptions was that the geopolitical situation remains constant.

A few days ago I wrote a column summarising the reasons for the sustained low oil price. The day after, Saudi Arabia and Iran broke off diplomatic relations as protesters set fire to the Saudi embassy in Tehran following the execution of a cleric in Saudi Arabia. Since then Qatar and Kuwait have recalled their ambassadors to Iran.

Why should this matter? After all, these rising tensions have not affected the price of oil as the Wall Street Journal reports. The continuing low oil price predictions seem unaffected because there is a glut of oil in the market at the moment.

Things could change. The nature of the confrontation between Iran and Saudi Arabia has a religious dimension and this could have unpredictable consequences. At the moment both countries are in conflict with one another by proxy in Yemen and Syria where hundreds of thousands of people have been killed and millions displaced. The tensions between the two countries run deep and threaten to surface as direct conflict. What happens here matters to the world of oil.

Five of the top ten oil producing countries are located in this region.

Top 10 oil producing countries

This is magnified further by the geography that has a critical chokepoint. The U.S. Energy Information Administration (EIA) defines world oil chokepoints as narrow channels along widely used global sea routes, some so narrow that restrictions are placed on the size of the vessel that can navigate through them. Chokepoints are a critical part of global energy security because of the high volume of petroleum and other liquids transported through their narrow straits.

Let’s take a closer look at the region. Iran and Saudi Arabia face each other over the Persian Gulf. 17 million barrels of oil are loaded on to tankers each day. These oil tankers have to pass though a narrow point called the Strait of Hormuz. Any direct conflict between Iranian and Saudi forces would probably halt this flow, which is 30% of all the oil traded by sea.

30% of all seaboard traded oil passes through the Strait of hormuz

At this point you might be thinking, surely this chokepoint has been anticipated and there is a backup supply plan. The short answer is yes; road tankers could transport several hundred thousand barrels of oil per day but this is a minor amount. Pumping oil through pipes is a more effective method of transporting the oil.

There are pipelines that can bypass the Strait of Hormuz. Some pipelines such as the Trans-Arabian Pipeline (TAPLINE) that runs from Qaisumah in Saudi Arabia to Sidon in Lebanon are not operational. There are two relevant operating pipelines: The Abu Dhabi Crude Oil Pipeline operated by the United Arab Emirates and the East- West Pipeline (Petroline) operated by Saudi Arabia.

The two operational pipelines do have some spare capacity and in theory could transport a further 3.7 million barrels of oil per day. Work published by Forbes has calculated that alternative supplies could make up the supply deficit and this would raise world oil prices by 15-20%.

This calculation assumes supply responding to demand instantly. Any delays will cause large price shocks in the market.

Another factor worth bearing in mind is the destination of the oil. Of the 17 million barrels transported each day, 85% is shipped to the Asian markets, principally Japan and China. At the time of writing China’s markets are in a fragile state with share trading suspensions leading some to wonder if the world’s second-largest economy is in deepening trouble.

Predicting exactly what events will emerge from all this complexity will be an impossible task, the best we can hope for is to look at the potential outcomes and prepare as much as we can.

One certainty is that China needs a Plan B when it comes to oil supply, but that, dear Investorintel reader is a story for a future column…


Adrian Nixon is a Senior Editor at InvestorIntel. He began his career as a scientist and is a Chartered Chemist and Member of the Royal ... <Read more about Adrian Nixon>

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