The War Risk Premium For Oil Prices
Last week’s attacks on two tankers in the Gulf of Oman have ratcheted up tension in the Middle East. Lloyd’s List has reported a tenfold rise in war risk marine rates for tankers.

Iran has increased its production of enriched uranium and says that on June 27 it will breach the quantity limit set under the nuclear deal agreed in 2015 with the P5+1 group of countries, the US, France, UK, China, Russia and Germany.

The US has said it does not want war, but its aim is to stop Iran developing a nuclear weapons capability, and that all options, including military action, are possible. The US withdrew from the nuclear agreement in May last year, later re-imposing unilateral sanctions on Iran.

Tanker attacks

The June tanker attacks follow four incidents that damaged commercial tankers off the UAE port of Fujairah in May and drone attacks targeting Saudi Arabia’s East-West pipeline system the same month.

The threat is that conflict between Iran and the US will close the Strait of Hormuz, affecting 18-19 million b/d of oil exports from Iraq, Saudi Arabia, Kuwait and the UAE, about one-fifth of global oil consumption, as well as oil, NGL and LNG exports from Qatar. Iraq would be limited to about 1 million b/d capacity on its northern export system via Turkey, including production from the Kurdish autonomous region, while Kuwait and Qatar have no alternatives.

Taken as a whole, the attacks appear specifically designed to threaten oil flows from the Arabian Gulf, indicating a capacity not just to close the Strait of Hormuz, but disrupt the two key alternative routes.

East-West pipeline

Saudi Arabia’s East-West pipeline (Petroline) runs about 730 miles across the Arabian Peninsula connecting oil fields in the Kingdom’s eastern province to the oil export point and refining center of Yanbu on the Red Sea. From here oil can flow north via the 2.3 million b/d Sumed pipeline and the Suez Canal into the Mediterranean or south into the Gulf of Aden.

The system comprises two crude oil lines of 48 and 56 inches respectively, one of which is also designed to carry natural gas. There is a parallel 26 to 30-inch 290,000 b/d pipeline carrying Natural Gas Liquids, which can be used to fuel the system’s 11 pumping stations, four of which are not connected to the national electricity grid, owing to their remote locations.

Built in 1982, capacity on the pipeline was increased to 5 million b/d in 1992. In 2016, state oil company Saudi Aramco announced that it was expanding the pipeline’s capacity from 5 million b/d to 7 million b/d by the end of 2018, although the status of this project is unclear. It has also been overhauling the Muajjiz oil terminal, which is expected to raise western coast loading capacity from 6.6 million b/d to 8.6 million b/d.

Tankers going to or coming from the Gulf of Aden have to traverse the Bab Al Mandeb strait between Yemen and Djibouti, which at its narrowest point is just 18 miles across. In 2016, according to US Energy Information Administration data, 4.8 million b/d of oil passed through Bab Al Mandeb. Saudi Aramco suspended passage through the strait temporarily last July following attacks on tankers attributed to Houthi militants. In 2017, the oil tanker MV Muskie came under RPG attack, which was attributed by western intelligence sources to Al-Qaida in the Arabian Peninsula.

In May, the Houthis launched drone attacks specifically targeting pumping stations on Saudi Arabia’s East-West pipeline, causing a short-lived suspension of pumping.

This has been interpreted two ways; firstly, as coordinated Iran-Houthi action against Saudi oil infrastructure and, secondly, as motivated more by a Houthi desire to stir anti-Saudi feeling in Yemen. The Houthis, who are fighting a Saudi and UAE-backed coalition, claim Saudi Arabia is plundering Yemen’s oil wealth. In June, they launched missile and drone attacks at targets in southern Saudi Arabia in apparent response to air attacks on Yemen’s capital Sanaa.

Fujairah pipeline

The second Strait of Hormuz bypass is the Abu Dhabi Crude Oil pipeline, which runs 236 miles from Habshan, which is the collection point for the UAE’s onshore crude production, to Fujairah in the Gulf of Oman south of Hormuz. The pipeline started full operation in 2012 with a capacity of 1.5 million b/d.

The attacks on the MT Front Altair and Kokuka Courageous in June were both in the Gulf of Oman east of Fujairah, while in May four commercial tankers were attacked off Fujairah. The latest attacks have been blamed on Iran by Saudi Arabia and the US. Iran has denied involvement.

Four means of attack have been employed in recent years, improvised waterborne explosive devices, limpet mines, missiles and drones, adding up to the equivalent of maritime guerrilla warfare. These are weapons meant to counter US conventional naval superiority.

Hardline positions

UN Secretary General Antonio Guterres has called for an independent investigation into the attacks to determine responsibility. But whoever is blamed – Iran, elements within Iran’s military acting independently of government, or an external actor hoping to foment war – and assuming the report provides conclusive results, the attacks’ correlation with the tightening of US sanctions on Iran is clear.

Since the remaining US waivers were removed in May, Iranian crude exports are estimated to have fallen as low as 500,000 b/d, 2 million b/d less than a year ago.

US strategy is to inflict severe economic damage on Iran in the hope that either the government capitulates and agrees to more severe restrictions on its nuclear activities and ballistic missile programs or that economic deprivation destabilizes it internally.

Venezuela’s near-permanent state of economic and social crisis indicates that this may take years to accomplish if it is achieved at all.

The problem is that US sanctions play directly into the Iranian state’s long-term narrative of foreign aggression as the principal cause of the country’s economic problems. Nationalism and religion will be used as unifying forces in the face of external aggression, strengthening the theocratic rather than republican strands of the Iranian revolution. A clear risk is that conflict against an external power – in a war that may have no conclusive victor – becomes the ultimate national unifying force and means of staving off internal collapse.

With both the US and Iran assuming uncompromising positions, the outlook is thus for a period of heightened war risk, rising insurance costs and an oil price premium acting as a counterbalance to increasing non-OPEC supply on the one hand and declining forecasts of oil demand on the other as global trade prospects turn ever bleaker.