The rise in the benchmark Brent oil price from just over US$72 per barrel (pb) to above US$80pb in a week highlights that the risk premium attached to the Israel-Hamas war is still very much in play in the global oil markets. Although other factors played a part in the oil price rise, a significant part of the increase was due to the rising danger posed to tankers moving oil from the Middle East to Europe via the Red Sea. This has long been the shortest and generally cheapest method to move oil via ships from east to west. However, several vessels – supposedly linked in some way to Israel, but some are not at all connected – have been seized by Yemen’s Houthi militants. The group remains overtly backed by Iran and covertly backed by Iran’s own sponsors, most notably in this instance Russia, but also China. Given the crucial importance of this transit route and the area surrounding to the global oil markets, things may become a lot worse very fast.
In many ways, the problem for ships of countries seen as aligned to the U.S. travelling through the Red Sea begins before the Red Sea is reached – in fact, somewhere east of the Oman coast of the Arabian Sea, which then flows into the Gulf of Aden, on the south coast of Yemen. It is at this juncture that ships must pass through the crucial chokepoint of the Bab-el-Mandeb Strait. This 16-mile-width waterway flows between the west coast of Yemen on the one side, and the east coasts initially of Djibouti and then of Eritrea on the other, before it joins the Red Sea. As it stands, never has the literal translation of the chokepoint’s name from Arabic – ‘The Gate of Grief’ - been more apposite than it is now. From the beginning of the Israel-Hamas War that effectively began on 7 October, the Middle East’s leading Shia Islamic power, Iran, has been looking to catalyse an expansion of the direct conflict between those two protagonists into a wider war between Islam and the Jewish state of Israel, which it thinks could draw the U.S. and its allies into another no-win war in the region. Tehran’s attempts to mobilise Lebanon’s Hezbollah militants – a much bigger force than Hamas, which Iran also supports with money, weapons, and training - into a simultaneous full-scale war against Israel have so far been unsuccessful, due in large part to the extraordinarily accomplished diplomacy of U.S. Secretary of State Antony Blinken and his team. Similarly unsuccessful – and for the same reason – has been Iran’s call for an embargo on the exports of oil by Islamic states to Israel.
One of the elements that has proved particularly effective in the efforts of Blinken and his team has been China’s avoidance - so far - of doing anything to encourage a broader escalation of military hostilities by Iran and its Middle East allies against Israel and its allies. Beijing maintains a very high degree of influence over Iran through the all-encompassing ‘Iran-China 25-Year Comprehensive Cooperation Agreement’, as first revealed anywhere in the world in my 3 September 2019 article on the subject and analysed in full in my new book on the new global oil market order. China’s reluctance to fan the flames of conflict in Israel or the Middle East as a whole is mainly due to its own precarious economic position, which would be made even worse if oil prices suddenly spiked much higher and/or the U.S. went back into full-scale Trade War mode with it. Although it can buy oil and gas at 30 percent or more discounts from its key Middle Eastern suppliers through various deals agreed in the past few years, the economies of the West remain its key export bloc, with the U.S. still accounting for over 16 percent of China’s export revenues on its own. According to a senior source in the European Union’s (E.U.) energy security complex spoken to exclusively by OilPrice.com recently, the economic damage to China – directly through its own energy imports and indirectly through damage to the economies of its key export markets in the West – would dangerously increase if the Brent oil price remained over US$90-95 pb for more than one quarter of a year. Beijing’s lack of appetite for an outright superpower showdown in the Middle East right now was signaled clearly by the recent visit to the U.S. of its President, Xi Jinping – his first in six years.
This said, according to the E.U. source, the Iranian-backed Houthis are not acting against vessels in and around the Red Sea without Beijing’s tacit approval. In brokering the stunning 10 March relationship resumption agreement between the Middle East’s major Sunni power, Saudi Arabia, and Shia counterpart, Iran, as also analysed in depth in my new book, China cemented the control it had over the key oil transit routes in the region. The previous 25-year deal with Iran gave Beijing influence over the Strait of Hormuz, through which around 30 percent of the world’s oil travels. The same deal also gave China a hold over the Bab el-Mandeb Strait (controlled on the Yemen side by the Iran-backed Houthis), and on the other side by Djibouti and Eritrea (both of which owe money to Beijing as part of ‘Belt and Road Initiative’-related loans made to them). It should not be forgotten that prior to the seizure of the Galaxy Leader cargo ship on 19 November – supposedly for being ‘Israeli-owned’ – Iranian forces also took two other oil tankers in a week at the beginning of May around the Strait of Hormuz. Neither of them were anything to do with Israel. Instead, said the E.U. source at the time, Iran seized them to demonstrate that it still had control over that transit route and, perhaps even more importantly, it was done with the full blessing of Beijing. “Although Xi [Jinping] doesn’t want a full-blown confrontation with the U.S. at the moment, he does want China to stay relevant to what’s going on there [in the events adjunct to the Israel-Hamas War] and having a role in this Red Sea problem achieves that,” he added last week.
The danger here for oil markets, of course, is if China changes its broadly cooperative posture towards Western interests as the Israel-Hamas War rages on. Such a change could come if Beijing felt that the U.S. an its allies were trying to push China back out of the geopolitical gains it has made in the Middle East in the past five years, as also analysed in full in my new book on the new global oil market order. A spark for this might come from any notable expansion or extension in ‘Operation Prosperity Guardian’ - a new multinational security initiative announced last week by the World Shipping Council. This came shortly after the U.S. Department of Defense stated that the initiative was being launched under the umbrella of the Combined Maritime Forces and the leadership of its Task Force 153. The Force so far comprises only countries allied to the U.S., including the United Kingdom, Bahrain, Canada, France, Italy, Netherlands, Norway, Seychelles, and Spain.
If China did take its foot off the brake with Iran, then the chances of an embargo on oil exports first to Israel and then to its allies would dramatically increase, bringing with it the prospect of a re-run of the events of the 1973 Oil Crisis, as examined in detail in my new book. This saw oil prices spike around 267 percent, from about US$3 per barrel (pb) to over US$11 pb, and stoked the fire of a global economic slowdown, especially felt in the net oil importing countries of the West. A broader oil embargo of the sort that Iran still wants would have similarly disastrous effects, if not worse. According to a recent assessment by the World Bank, a loss in global crude oil supply of 6-8 million bpd – which it refers to as a “large disruption” scenario comparable to the 1973 Oil Crisis - would result in a 56-75 percent increase in prices to between $140 and $157 a barrel. However, a broadening out of the embargo on Israel by the Islamic members of OPEC, as called for by Iran, would likely lead to a much bigger loss of global oil supplies than the World Bank has calculated. The Islamic members of OPEC are Algeria, with an average crude oil production rate of around 1 million barrels (bpd), Iran (3.4 million bpd), Iraq (4.1 million bpd), Kuwait (2.5 million bpd), Libya (1.2 million bpd), Saudi Arabia (9 million bp), and the UAE (2.9 million bpd). This totals just over 24 million bpd - or about 30 percent - of the current average total global production of about 80 million bpd.
By Simon Watkins for Oilprice.com