Oil Market, Exposure to the Middle East & the Saudi Arabia-Iran-US axis

Given the ongoing straight of Hormuz crisis I thought it might be interesting gathering some information. The interest arises from the potential human and economic losses associated with any further escalation. Here I’ll focus on the economic aspect in the hope that the human toll will not actually happen. The issue is of course that an increase in oil prices is a well known economic shock, best understood as a contraction in aggregate supply that increases inflation and contracts output (GDP). This is not an abstraction, even for the EU, who has more or less cut all ties with Iran, given the transmission of transport costs to the consumer prices, in the event of an actual closing of the straight of Hormuz.

In my opinion any diplomatic solution is only reachable via an economic-military trade-off where the USA (1) withdraws the sanctions, (2) starts pushing for Saudi openness to Iranian investments and (3) promises to not intervene in Syria at the bequest of the Arab league (but maintains a military presence in the Persian gulf) in exchange for an end to the Iranian Nuclear programme.

 

Oil Exposure

Reuters has an interesting map of Middle East Oil Traffic Choke points, highlighting some of the most important strategic points for the Oil market in the Middle East.

It should make clear the strategic importance of countries such as Egypt, Turkey, Saudi Arabia, Bahrain, Iran, Yemen, Eritrea and Somalia. If it isn’t then the map below of US military bases in the region (or this one) should help. The overlap is blatant.

If human rights violations are not exactly upheld, this map ought to provide you with an insight as to why governments are not about to get involved.

The Oil Market

Suppliers: OPEC is an organisation of (at present) 12 countries (Iran, Iraq, Saudi Arabia, Qatar, KuwaitUAE, Lybia, Algeria, NigeriaAngolaVenezuela and Equador) represents 89% of estimated world oil reserves.

Of course reserves are not actual production, but rather potential production. The figures for production is slightly different, as the figure below (compiled from the latest OPEC Monthly Oil Market Report) shows.

Clearly, Iran is producing “above potential” while Venezuela is producing much below.

Consumers: As the figure below shows, the largest consumers of oil, between 2009 and 2010, were Americans, Europeans, Chinese, Japanese. I seem to remember the figures relative positions changing in favour of China, but I could not find figures on it. Either way, the point is that these 5 economies consumed alone over 50% of the world’s oil resources.

Prices: The charts below (taken from the OPEC) shows the price of oil over last 12 years, 12 months weeks and since the beginning of December 2012, respectively. Clearly the price of oil  has reached an 11 year peak which is expected to continue to grow into a 12 year peak in the next 12 months.

Moreover, it clearly displays a pronounced increase in the middle of December when the crisis began. Note that the IEA is able to intervene in oil markets by boosting supplies with stored reserves. However, given the finite stock of oil available to the IEA, this is never sufficient to have a lasting effect. This was the case in June-July 2011, when the IEA performed such an intervention. Although it was met with initial success, the 2 first charts in the figure above should make it clear that that intervention failed to have any permanent impact.

Exposure to Iran

As the third largest holder of oil reserves and the second largest producer, Iran is not a oil producer to be dismissed. However, assuming that the figures below are representative, dependency on it is not excessive, for most countries. If the world was ruled from Sri Lanka, the crisis would have been over a long time ago, and I’m not sure the EU would be as eager to impose sanctions on Iran if Turkey were a member state. But none of these things are true, so in their isolation these countries must bear the policies of others.

For what it’s worth, market operators do not seem to very worried about the situation in Iran. According to Reuters, they expect any shortfall from oil sales from a potential crisis between the USA and Iran in the straight of Hormuz to be more than compensated by sales from Saudi Arabia and from Lybia. It seems to me that this optimism fails to take into account the transportation costs that such an escalation could create, and their transmission to the consumer, which could push prices above US$ 200. So I’m not as optimistic. But I am no oil or Iran specialist.

The Saudi Arabia – Iran -USA geopolitical Axis

Stratfor had an extremely interesting research article about the causes of this conflict and the possibility of a deal. According to  their analyst, George Friedman, the problem is a geopolitical one where a decadent and overstretched hegemon attempts to contain a ambitious regional power who itself feels surrounded by enemies and seeks to guarantee its sphere of influence. In a sense everyone is posturing to defend their own status quo.

  • The West does not want an oil shock or a Nuclear Iran threat.
  • This last fear is shared by Saudi Arabia.
  • Iranian elites, on the other hand, want to ensure the continuity of the present regime and that it does not have to endure Saudi economic, political and religious/social impositions.
  • Ultimately, the problem is that the USA and Iran see each other as unpredictable.In my opinion any diplomatic solution is only reachable via an economic-military trade-off,where the USA
    1.  withdraws the sanctions
    2. starts pushing for Saudi openness to Iranian investments
    3. and promises to not intervene in Syria at the bequest of the Arab league

in exchange for an end to the Iranian Nuclear programme.

Again I’m not the specialist, but it seems to be the only reasonable thing if you dismiss the ludicrous possibility that Iranians are irrational religious fanatics actively seeking a shortcut to  Heaven.

Either way our prosperity and safety might come at the expense of tens if not hundreds of thousands of Syrians who want nothing more than their freedom, so there’s nothings to be happy about.

————————————————————————————–

Here are some selected quotes from that article:

The Iranian Perspective: Apparently, Iran wants 3 things:

  1.  “It wants the United States to reduce its presence in the Persian Gulf dramatically (which as shown before is quite intense). Having seen two U.S. interventions against Iraq and one against Afghanistan, Iran is aware of U.S. power and the way American political sentiment can shift. It experienced the shift from Jimmy Carter to Ronald Reagan, so it knows how fast things can change. Tehran sees the United States in the Persian Gulf coupled with U.S. and Israeli covert operations and destabilization campaigns as an unpredictable danger to Iranian national security.”
  2. “The Iranians want to be recognized as the leading power in the region. This does not mean they intend to occupy any nation directly. It does mean that Iran doesn’t want Saudi Arabia, for example, to pose a military threat against it.” This is relevant in light of the Syrian conflict, the brutality of which creastes an evironment where “for the first time, there is the potential for a militarily viable target set for outside players acting on behalf of the rebels. The existence of that possibility might change the dynamic in Syria. When we take into account the atmospherics of the Arab League demands for a provisional government, some meaningful pressure might actually emerge. (…)  This raises the risk that the sphere of influence Tehran is pursuing will be blocked by the fall of the al Assad regime. This would not pose a fundamental challenge to Iran, so long as its influence in Iraq remains intact, but it (…) could open the door to recalculations in Tehran as to the limits of Iranian influence and the threat to their national security.(….) Iran has long felt that its natural role as leader in the Persian Gulf has been thwarted, first by the Ottomans, then the British and now by the Americans, and they have wanted to create what they regard as the natural state of things.”.
  3. Iran wants a restructuring of oil revenue in the region. How this is formally achieved — whether by allowing Iranian investment in Arabian oil companies (possibly financed by the host country) or some other means — is unimportant. What does matter is that the Iranians want a bigger share of the region’s vast financial resources.”

The USA Perspective: With the Pyrrhic victories in Afghanistan and Iraq and in the aftermath of the subprime crisis, the USA is no longer the uncontested super power. According to that analyst,

  1. “The United States and its allies do not want Iran to get nuclear weapons. But more than that, they do not want to see Iran as the dominant conventional force in the area able to use its influence to undermine the Saudis”. This is problematic in terms of the regional influence that Iran gained in the aftermath of the downfall of Saddam Hussein.
  2. “The United States doesn’t want a conflict with Iran. Iran doesn’t want one with the United States. Neither can be sure how such a conflict would play out. The Iranians want to sell oil. The Americans want the West to be able to buy oil. The issue really comes down to whether the United States wants to guarantee the flow of oil militarily or via a political accommodation”
  3. If so, it is possible to see the USA as happy to lower sanction on Iran if the latter drops its nuclear programme. But it is unlikely that they try to accommodate them in exchange of vague and ambiguous commitments.

The Saudi Angle: This is where the analyst from Stratfor looses me. An hypothesis is made that the USA might choose to drop the Saudis and replace them by the Iranians. This makes no sense to me. The Saudis are reliable partners, where the USA has physically settled its military. It is accommodating and richer in oil. The Iranians are not. For the USA to pursue such a policy would not be out of preference for dealing with Iran but rather due to lack of choice caused by financial hardship. In that case there won’t be a trade off between Iranian and Arabic support but rather a complete withdrawal from the region by the USA. Let’s hope that by then the world has developped an efficient way to exploit solar energy…

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