This is blog 3 in our 3 blogs on the US Mon morning announcement to not give any more waivers to import Iranian oil and condensate and to cut Iran’s exports to zero. Its been a good two days for oil prices. Its early and its still not clear how successful the US will be in cutting Iran’s exports to zero and who will step up to fill the gap. We wrote these 3 blogs to look at the scenario of the US cutting Iran’s oil exports to zero. Blog 1 worked thru the math that shows US and OPEC+ added exports can closely match cutting Iran’s exports to zero. Blog 2 said that just matching Iran’s lost export barrels won’t be enough to stop oil prices from going up unless there is a major release of oil from the US SPR and/or Saudi oil inventories. Today’s blog looks at the key potential risks to oil by the US putting Iran’s back to the wall. Iran’s focus so far is to make the argument and get international support to not let the US force Iran’s exports to zero. Its basically a negotiation and wait and see phase. If Iran is not successful in stopping the US cutting its exports to zero or very close thereto, it will bring focus to the two primary (and both significant) risks to the global oil supply chain – Iran in the Strait of Hormuz and its Houthis surrogates in the Bab el Mandeb/Red Sea. No surprise that in this phase, Iran threw out its normal warning on oil tankers thru the Strait of Hormuz if Iran can’t export barrels. We may see some harassment and delays to tanker traffic from Iran, but we do not expect any official military action on a disaster scenario of Iran attacking tankers in the in the Strait of Hormuz leading to a war in the Persian Gulf. Any attack would be a desperation act and we believe there would be some signals of nearing that point in advance thereof. Rather we see the primary direct risk to the oil supply chain being Iran’s surrogates, the Houthis. Lastly, we realize that there is no chatter for the potential of some sort of indirect negotiation, but we have to wonder if Iran was throwing out a feeler yesterday when it called the Strait of Hormuz an “international waterway” and not waters under Iran control/rights.
US is pulling its Venezuela regime change playbook out for Iran – basically a semi siege to squeeze cash flow and hope the people force regime change. The Trump administration is consistent including their negotiating and regime change playbooks. It looks like they are using the Venezuela regime change playbook in Iran – increasingly cut off cash flow, try to force the unwanted leadership to make massive change to their position, and set the stage for the people to demand regime change. Iran has already been feeling the impact of the US sanctions with oil production down ~1 mmb/d YoY and less foreign investment capital flows into Iran’s projects including major natural gas development at Pars. This next phase of cutting oil and condensate exports to zero will increase the pain level and mean the loss of ~$85 million per day in revenues.
At this stage, Iran is primarily focused is minimizing damage by rallying international support. Its too early to see how successful the US will be in cutting Iran’s oil and condensate exports to zero. Iran remembers what happened in Nov when Trump surprised the Saudis by granting last minute waivers. So no surprise, Iran’s focus so far is primarily on rallying international support that cutting Iran’s exports to zero is wrong and a big negative to oil markets. Iran will want to see how successful China, India and Turkey, in particular, are in getting some continuing waivers. At the same time, Iran is reminding the EU and others that it has been complying with all terms of the nuclear deal. And Iran is also meeting with Russia to see how they can help. Right now, for Iran, it’s a focus on minimizing damage. Its too early for any direct action.
Iran is also playing its key warning card – threatening oil tanker transit thru the Strait of Hormuz, the world’s most important oil chokepoint. The most significant Iran related risk to the oil markets and the global economy is the Strait of Hormuz. No one should be surprised that Iran’s first play to try to minimize any damage was to threaten oil/LNG tankers traffic thru the Strait of Hormuz. All of the discussion on Iran and risks to oil markets will firstly focus on the Strait of Hormuz and the risk to oil, petroleum products and LNG tankers thru the world’s most important chokepoint. Iran’s first play in response was to remind the world that there is the risk oil and LNG tanker traffic thru the Strait of Hormuz. The Strait is the world’s most important chokepoint for oil with daily tanker volumes of approx. 19 mmb/d and 30% of the global LNG trade ie. all of Qatar’s LNG. It is located between Oman and Iran. Its not just that is only 21 miles at its narrowest point. The logistical issue is that this is a narrow chokepoint for tanker traffic comes because it is an extremely narrow traffic route at least for the greater water depths to allow ease of supertanker traffic. There are separate inbound and outbound 2 two-mile wide shipping lanes plus a two-mile wide buffer zone. The Mehr (Iran news) story “Iran to block Strait of Hormuz if its benefits denied: IRGC Navy cmdr” [LINK] quoted IRGC Navy Commander Rear Admiral Alireza Tangsiri “if Iran’s benefits in the Strait of Hormuz, which according to international rules is an international waterway, are denied, we will close it.”
Volume of Crude Oil and Petroleum Products Transported Through World Chokepoints
Did Iran throw out a feeler and soften its stance on the Strait of Hormuz or did Tangsiri make a rookie mistake? The Mehr story also noted that Rear Admiral Tangsiri just took over in this role. The market focus on his statement was his threat on other countries tanker traffic, but we were surprised by his comment that the Strait of Hormuz is an international waterway and not the standard Iranian line of being in Iranian waters. We wonder if Iran is throwing out a feeler that they will soften their stance on claims to the Strait of Hormuz or did Tangsiri make a rookie mistake in his comments to Mehr. We don’t recall ever hearing this position. We just wonder if they are throwing out a feeler for a potential future indirect negotiation. We believe Iran knows that any official attacks on tankers would result in a massive counter attack and lead to big losses. They must know that this would be a desperation act, which is also why we wonder if they are throwing out a feeler. To date, Iran has had a strong view and belief for its control of the Strait of Hormuz was from its view that it owns three key strategically located islands – Abu Mousa, Greater and Leser Tunbs. The US and others do not recognize the Iran ownership claim and therefore believe that Iran does not have any right to impact oil and LNG flow thru the Strait of Hormuz. Whereas Iran has physical control and also claims territorial control. These islands are strategically located at the west (north) side of the Strait of Hormuz and in theory provide support to Iran’s territorial rights over part of the Strait of Horumz. There is a long standing dispute on the islands since the Nov 1971 Memorandum of Understanding signed between Iran and Great Britain. The MOU was signed by Great Britain since the UAE was not formally founded as a country until Dec 1971. UAE has claimed the islands as theirs from the start. The US and UK and others didn’t make this an issue in the 70’s because of their support for the Shah of Iran. But post the 1979 Iranian revolution, UAE has had strong support for their position. However, the UAE has not yet been successful in getting its claim to international courts (as opposed to the Philippines success in the South China Sea against China, unfortunately which hasn’t meant much). The significance of these islands is water depth for super tankers. The below map [LINK] shows Abu Mousa, Greater and Lesser Tunbs and the water depths in the Strait of Hormuz.
Strait of Hormuz – Abu Mousa, Greater and Lesser Tunbs
The US is already warning Iran to not think about messing with oil tankers in the Strait of Hormuz. The US knows that any disruption to oil tankers thru the Strait of Hormuz would drive oil prices up and up big. Its why they are being proactive to warn Iran. Earlier this morning, we tweeted [LINK] “US reminds Iran it shouldn’t even think about messing with oil tankers in Strait of Hormuz. Aircraft carriers: USS Abraham Lincoln going to Persian Gulf, USS John C. Stennis going to Mediterranean Sea. Multiple other navy assets in Persian Gulf.” Jerusalem Post reported of the buildup in US navy assets in the Persian Gulf and Mediterranean Sea, which included two of the US’s 11 aircraft carriers strategically positioned to help protect oil supply chain – the USS Abraham Lincoln is now in the Persian Gulf and the USS John C. Stennis in the Mediterranean Sea. The Jerusalem Post also noted a number of other significant US Navy assets in the Persian Gulf. These aircraft carriers and other naval asserts seem ideally positioned to make sure no issues from Iran in the Strait of Hormuz, and also to give support if anything goes awry in Libya.
Its only a warning threat, but even raising the risk will inevitably add some cost and timing impact of oil tanker transit thru the Strait of Hormuz. This is only an Iran warning threat. There is always the risk for a random unofficial attack on a tanker, maybe by a small boat with explosives or small rocket attack by an individual, but we don’t believe any such random attack will be the official strategy. We have to believe it will be very difficult for Iran to directly attack an oil tanker as Iran risks a response from the US, Saudi, UAE and likely others if there was any attack on an oil or products tanker in the Strait of Hormuz. We believe any official Iran attacks on oil tankers would not happen until a desperation point and we believe some signals in advance thereof. However, even without an actual attack, we would expect to see some harassing of tankers and also believe the threat of potential attacks or even disruptions to tanker traffic will impact the cost and tanker times thru the Strait of Hormuz. It could be simple items like insurance, but also planned scheduled transits to ensure there is nearby naval ship presence.
Iran is just doing its normal warning threat right now, but 30 years ago, there was actual military action in the Strait of Hormuz. Most probably don’t remember the 80’s and the Iran/Iraq war, which started on Sept 22/1980 when Iraq invaded Iran, and ended on Aug 20/1988 with a UN brokered ceasefire. It was a long war and one that in 1987 [LINK] included air attacks on super tankers and Iran’s major oil export terminal, Kharg Island, attacks on Iranian mine layering ships, multiple small boat attacks against ships including tankers and air attacks on offshore Iranian oil platforms. This was real military conflict and also included attacks on other countries (ie. Kuwait) tankers. But it was an Iran vs Iraq war and not like today’s situation.
The bigger potential direct risk to the oil supply chain – will Iran’s surrogates attack oil tankers in the Bab el Mandeb or Saudi oil and gas infrastructure? The Houthis are likely the primary risk to oil supply interruptions, especially if they are able to replenish their missiles strength. This is no different than the last two years as the Houthis have attacked oil tankers thru the Bab el Mandeb chokepoint and launched missiles at key Saudi cities with major oil and gas infrastructure. Iran has long been accused of smuggling missiles to the Houthis and there will be an increasing watch against any increase thereof. The Houthis have attacked key Saudi Arabia cities with major oil and gas infrastructure with missiles, and also successfully attacked Saudi oil tankers in the Red Sea on their voyage thru the Bab el Mandeb. Yesterday, the Houthis leader, Abdulmalik Al Houthi warned [LINK] “Our missiles are capable of reaching Riyadh and beyond Riyadh, to Dubai and Abu Dhabi”. The EIA writes “the Bab el Mandeb Strait is a chokepoint between the Horn of Africa and the Middle East, and it is a strategic link between the Mediterranean Sea and the Indian Ocean. The strait is located between Yemen, Djibouti, and Eritrea, and it connects the Red Sea with the Gulf of Aden and the Arabian Sea. Most exports from the Persian Gulf that transit the Suez Canal and the SUMED Pipeline also pass through Bab el-Mandeb. An estimated 4.8 million b/d of crude oil and refined petroleum products flowed through this waterway in 2016 toward Europe, the United States, and Asia, an increase from 3.3 million b/d in 2011″. It was one year ago that the Houthis hit a Saudi oil tanker with a missile just before the Bab el Mandeb. Last April, the Saudi’s acknowledged a Houthi missile hit and damaged the Saudi oil tanker Abqaiq. There have been other missile and boat attacks on tankers in the Red Sea/Bab el Mandeb. There were also several long range missiles launched at Riyadh, Yanbu and the UAE in 2018. The Houthis are not afraid to launch long range missiles against Saudi Arabia like they did in 2018 at the capital Riyadh and the major Red Sea oil refinery and export terminals at Yanbu.
Map of Yemen and Bab el-Mandeb
The US recognize the Houthis risk is real and are also already warning the Houthis. The Houthis threat isn’t just a threat, the Houthis have been successful in hitting oil tankers in the Bab el Mandeb/Red Sea and in reaching Riyadh. The Houthis threat is acknowledged by the US. Reuters reported today [LINK] “The United States called on Iran to keep the straits of Hormuz and Bab al-Mandab open, a State Department official said on Tuesday after the United States a day earlier demanded that Iran oil buyers halt their purchases by May 1. “We call on Iran, and all countries, to respect the free flow of energy and commerce, and freedom of navigation” in the straits, the official said.”