Javier Blas – Financial Times November 8, 2011
The oil market has rediscovered an old foe: Iran.
The price of Brent crude, the global benchmark, has rallied to almost $115 a barrel as the war of words between Israel and Washington, on one side, and Tehran over its nuclear programme escalates.
Oil traders are used to brinkmanship between western countries and Iran. But three elements make the latest standoff more dangerous than at any point over the past three years. One, the market is already battling with supply disruptions in Libya, Yemen and Syria; two, crude oil inventories, particularly in Europe, are sharply lower; and three, the starting point for a price rally is much higher than in the past.
This combination of tight fundamentals and rising geopolitical tension has driven up oil prices more than 16 per cent, from an eight-month low of $99.7 a barrel in early October. Prices remained elevated on Tuesday as a long-awaited report from the UN’s International Atomic Energy Agency said Iran had carried out work for developing a nuclear weapon and may still be doing so.
“Oil prices continue to face upward price pressure because of supply uncertainty resulting from ongoing unrest in the oil-producing regions of the Middle East and north Africa,” the US department of energy said in a report on Tuesday.
Iran is the world’s third-largest oil exporter, after Saudi Arabia and Russia, making the country an important cog in the global oil market. Last year, Iran sold an average of 2.6m barrels a day, mostly to Japan, China and India. Moreover, the country exerts a grip over the strategic Strait of Hormuz, the gateway for Middle East oil.
The strait is important because 15.5m b/d of oil passes through it each day, equivalent to a third of the all seaborne traded oil. The strait has added significance because all the world’s spare production capacity, the first line of defence against supply disruptions, is in Saudi Arabia, the United Arab Emirates and Kuwait. These exports would be constrained if the gateway was closed.
The main worry among traders is that Israel launches a unilateral surprise attack to try to destroy Iran’s nuclear facilities and that Iran retaliates by closing, even if only briefly, the oil flow through the Strait of Hormuz.
“It is the $200-a-barrel scenario”, says Philip Verleger, an independent consultant who correctly predicted in August 1990 the price rally after Iraq invaded Kuwait.
Ehud Barak, Israeli defence minister, played down on Tuesday speculation that Israel intended to launch a unilateral attack against Iranian nuclear facilities. But in an interview with local radio, he warned: “We are probably at the last opportunity for co-ordinated, international, lethal sanctions that will force Iran to stop.”
The problem, as Helima Croft, a political analyst at Barclays Capital in New York, notes, is that the previous four rounds of UN sanctions have yet to slow down Tehran’s nuclear programme. “We are in a more dangerous situation than two years ago,” she says, noting that the oil market has been too complacent.
The Rapidan Group, a Washington-based consultancy, has released a survey that offers a crucial insight into the psychology of the oil market as tension in the Middle East rises.
The consultancy, run by Robert McNally, a White House oil adviser from 2001 to 2003, asked market participants what price response they anticipated in the event of a surprise Israeli attack in March 2012 against Iran’s nuclear programme, taking into account current supply, demand and inventories fundamentals. The responses pointed to the potential for a huge price rally.
In the first hours of the attack prices would surge, on average, by $23 a barrel, according to the survey. Under the worst case scenario, including the closure of the Strait of Hormuz, prices could increase, on average, by $61 a barrel, lifting Brent crude to an all-time high of $175 a barrel. Some traders warned that the increase could be much bigger, pushing oil prices up by $175 a barrel to a dizzying $290 a barrel.
The survey points to a larger price rally than when the consultancy ran a similar analysis a year ago because the market fundamentals are stronger today. The tightness is due to a wave of supply disruptions that have drawn down stocks.
European crude oil inventories plunged in August, the last data available show, to their lowest in almost nine years due to a series of “supply-side factors”, according to the International Energy Agency. Among those production factors were the loss of Libyan supplies, North Sea production outages, pipeline sabotage in Nigeria and “the gradual redirection of Russian crude flows towards Asia”. Crude oil stocks are also low in Asia, and have fallen recently below the five-year average in the US.
The supply glitches continue to plague the market. Although Libya’s oil output has recovered to about 550,000 b/d, it remains well below the prewar level of 1.6m b/d. At the same time, oil production in Yemen and Syria has dropped by a combined 200,000 b/d due to unrest in both countries. In addition, production is running below the expected level in the North Sea, Nigeria and Azerbaijan.
With so much disruption already affecting the market, traders say Tehran is one risk they could do without.