With the US-Iran conflict moving into its third month, an ominous suspense pervades global energy markets. The blockade of the Strait of Hormuz has halted the flow of a fifth of the world’s oil and liquefied natural gas supplies, and triggered the largest energy disruption in history. With more than a billion barrels of oil already lost, the soaring benchmark crude prices are maintaining an extreme upward pressure on refined products like diesel and jet fuel, with a cross-sectoral effect. The shortage of sulphur (a by-product of crude oil and gas processing critical for fertiliser production) and loss of fertiliser shipments from the Persian Gulf could affect global food security. Stalled projects and job losses are inevitable as cost cutting becomes unavoidable. The economic pain is sure to prevail at all income levels.
Efforts to artificially stabilise markets and curtail inflation shocks prompted major oil consumers and the International Energy Agency—comprising 32 member, 13 association and six ‘accession’ countries—to initiate a historic release of strategic reserves. One of the criteria for the agency’s membership is the “capability of contributing its share of an IEA collective action which would be initiated in response to a significant global oil supply disruption and would involve IEA member countries making additional volumes of crude and/or product available to the global market (either through increasing supply or reducing demand)”. Out of the pledged release of 400 million barrels, 164 million barrels have already entered the global markets, according to the latest IEA report.
Saudi Aramco and Abu Dhabi National Oil Company bypassed the choked maritime route and partially mitigated the loss of supply through alternative overland pipelines. However, these supply measures proved insufficient in addressing price volatility. On the other hand, demand curtailment is only a temporary panacea as stockpiles are fast depleting and parleys between the combatants are failing to make headway.
Most developed and emerging economies hold strategic petroleum reserves (SPRs) to enhance energy security in periods of exigency. Japan and South Korea follow a public-private partnership for their SPRs, leasing underground storage facilities to domestic private refineries under mandate and foreign oil producers like ADNOC that maintain huge stocks with a right to export a portion of it with the host country having the first right of refusal. India partnered with ADNOC to store crude at two State-owned strategic underground facilities in India, with a third site under development with a total capacity of 30 million barrels when fully operational. At current demand, it translates to seven days of stocks, far below the 90-day benchmark set by the IEA. Yet, it lays a roadmap for future expansion and a PPP model.
The UAE’s exit from Opec on May 1, in the midst of the Iran war, added complexity to an uncertain market. Though the fourth largest member’s walkout initially fuelled a fear of group politics, a more sanguine picture has emerged since. Relieved of quota restrictions, as it aims to enhance production to 5 million barrels per day, Abu Dhabi has accelerated construction of a West-East Pipeline to Fujairah, bypassing the Strait of Hormuz. Slated to be operational by 2027, it shall double the Emirati oil export capacity and substantially slake Asia’s thirst.
Meanwhile, Brazil has reported much larger volumes of crude exports to Asia during the present disruption. As mentioned in this column last November, with rising production volumes at the Tupi and Buzios offshore assets of Petrobras, the low-sulphur Brazilian-grade crude has captured a larger portion of the Asian markets. Despite freight constraints, its share in China’s imports rose to 18 percent in April from less than 10 percent in January. On the back of well-negotiated prices, the Latin American medium-sweet crude has expanded its presence in the Indian energy mix, too. Besides State-owned refineries, Reliance remains a key buyer in the spot market for Brazilian crude and accounts for a major portion of Petrobras’s oil shipments to Asia.
However, African sources such as Nigeria, Angola and Libya have provided limited succour to Europe and Asia. Despite holding the 11th largest reserves in the world, Nigeria’s oil industry, with many small refineries, is vulnerable to several operational and security hurdles. The sector, which has historically battled under-investment, pipeline vandalism and poor turnaround maintenance, is prone to outages. However, the Lagos-based Dangote refinery, Africa’s largest with a capacity to process 650,000 barrels a day, has significantly increased shipments of jet fuel and diesel to Europe to partially fill the supply gaps caused by the West Asian tensions.
Donald Trump’s recent visit to Beijing emerged as Washington’s diplomatic overture, suggestive of a meeting between two equals rather than a competition for global supremacy. With the grim energy situation in the background, and in a bid to pursue the G2 framework, Trump followed up on the discussions with Xi Jinping with a hint of easing sanctions on Chinese independent ‘teapot’ refineries that process Iranian crude. Hengli Petrochemical, China’s second-largest teapot refinery, is considered to be one of Tehran’s largest customers for crude, as per a US Treasury report.
Coming amid an escalating geopolitical showdown, the development is viewed as an effort to manage global oil dynamics as much as heralding a new phase in US sanctions policy. Could the move legitimise Iranian oil’s continued presence in Asian markets and the ‘shadow fleets’ that facilitate such transits, as Washington woos Beijing to broker peace? It seems America is keen to segregate its business of war from the economics of oil by any means.
Given the current global shortage and China’s continued oil trade with Russia, the US Treasury extended the Russian oil waiver a second time. The continued flow of Urals is expected to temporarily stabilise the crude market and provide renewed energy security to the two largest consumers, China and India. The move shall augment supply of sulphur and other oil derivatives, enabling a surge in fertiliser production.
Few analysts predict the war to end by early June. Markets absorb this with cautious optimism as it may take months of normalisation to touch pre-war volumes. While new sources of oil emerge and their durability remains restricted, a collective initiative of nouveau rentiers might just bail out the situation.
Ranjan Tandon | Senior markets specialist and author
(Views are personal)