Possible Blockade of Hormuz Strait and Its Effects on Energy Market - Yiğit Mert Yüreklitürk

Hormuz Strait is one of the essential chokepoints in the world. It provides passage for six country’s exports to the world (Iraq, Iran, Bahrain, Qatar, UAE, and Saudi Arabia), especially in the energy market. Approximately %30 of globally consumed petroleum passes through the strait. Hence, it holds great importance for the world economy, and it is a natural target for Iran when there are threats against their will. Tehran has made similar declarations about closing the narrow Strait of Hormuz over the past 40 years (since Britain’s withdrawal of its military forces from the Gulf back in December 1971), whenever it has felt threatened.

As it occurred in the past, killing of Qasem Soleimani by U.S. strike in Baghdad and the developments that took place after the incident, once again turned Iran’s attention to Hormuz Strait, for possible retaliation. Trump’s call for extended sanctions & embargoes over Iran was hinged to a thwart towards Iran’s oil export. Even this implication itself is enough for Iran to threaten the Hormuz Strait despite severe consequences for themselves. Such a move would push international oil markets into considerable turmoil.

First, as the result of the blockade, higher crude prices would likely similarly affect everyone, even with a release of IEA strategic stocks. If it lasts long enough, the crisis and high oil prices would have a dumping effect on global energy consumption and could result in a worldwide economic slowdown. Because typically, when volatility increases in the oil market, OPEC (and its leader Saudi Arabia) steps in, uses its spare capacity, and avoids any hard swings at prices to protect both sides. However, with a blockade or severe limitation in traffic in the Strait of Hormuz, Saudi Arabia’s ability to release its spare capacity to the market would be significantly impeded, if not disabled altogether. Moreover, because of sanctions, countries like Venezuela and Iran (countries with vast spare capacity) cannot step in either. This sudden power vacuum in the oil market leaves only two countries to take responsibility: the USA and Russia. When it comes to the USA, crude production is led by private companies, meaning that the market dictates it. Additionally, crude quality around the world is not the same everywhere. For example, the U.S. shale is lower in density (lighter) and sweeter (includes less sulfur). Hence, it cannot immediately act as a substitute.

Only and the right option to take action is Russia. They already produce a crude that can be a substitute for Saudi oil, and an agreement that stipulates production cut with OPEC was signed to prevent oil prices from falling too low in a high-supply environment. The status quo was already unnerving for Russian oil companies so that they would agree to increase their productions. Besides, Russia signaled it would be able to provide additional supplies after the attack on the Saudi Arabian oil facilities (2019 Abqaiq – Khurais Attack) late last year, which sets an example for their readiness to fill in the gap because it is quite beneficial for them if they choose to do so. Russia would be ahead of the game in terms of both actual revenues and terms of geopolitical influence. Moreover, it is a fact that crude is traded in U.S. dollars, the currency that Russia thoroughly needs. Thus, higher prices and production would alleviate the burden over the Russian budget after the U.S.-imposed sanctions on Russian financial institutions.

Overall, just as it wasn’t blocked in many Iranian threats over political conflicts over the years, Strait of Hormuz seems to stay open for now, but blockade is always a possibility. Therefore, it is crucial to think through the potential effects that a blockade could have not only on pricing or availability of crude but also on the geopolitical power transfer to a player like Russia—which is already seen as strategic and diplomatic beneficiary of the U.S.-Iran conflict as well as the forced departure of U.S. forces from Iraq.

2020 All Rights Reserved