Oil Markets, Oil Attacks, and the Strategic Straits

Last week, a UK Navy vessel interposed itself between a British-flagged oil tanker and several small boats that attempted to impede its passage through the Strait of Hormuz. The British Foreign Office attributed the event to Iranian forces. Iran has denied those allegations. Less than a week before this incident, Gibraltar law enforcement, assisted by UK military forces detained an Iranian oil tanker entering the Mediterranean, for alleged violations of Syrian sanctions. And today reports have emerged that Iran has seized a British tanker at the Strait of Hormuz less than 24 hours after an incident in the same vicinity yesterday, where the USS Boxer downed a drone following a series of reportedly intense encounters with the Iranian military. As our colleague Frank Verrastro has pointed out here, the situation is about as complicated as it gets and has further stoked fears of possible disruptions in the oil market, which has witnessed a spate of oil facility and tanker attacks in the Middle East over the course of the past two months.
With Iran continuing to successfully deploy plausible deniability tactics, the series of sabotage attacks on tankers have served to further escalate tensions with the United States and its regional allies and heightened tensions for commercial shipping in the Persian Gulf but resulted in no engagement between forces to date. These events have also come at a time of geopolitical uncertainty for many countries given musings by President Trump last month questioning the need for continued U.S. military presence to defend the waterways in the region. The following analysis takes a deeper look at these events, the threat that they pose to the oil market, and how the current strategy to protect oil flows from the Persian Gulf is evolving.

The Strategic Strait of Hormuz and Global Oil Markets

The most recent episode involving three, allegedly Iranian, paramilitary vessels and a British flagged oil tanker transiting near the Strait of Hormuz is just one in a series of events of this nature to make headlines in the oil market in recent weeks. A few weeks earlier, a total of six tankers were sabotaged over the course of a single month in the Gulf of Oman, and in the wake of these attacks, Iran shot down an unmanned U.S. surveillance aircraft over the Strait of Hormuz. And while the vicinity of the Strait of Hormuz has become the epicenter of the most recent string of strikes on oil assets in the Middle East, other strategically important areas for oil production and flows have witnessed assaults over the course of the past year as part of a wider escalation of tensions in the region. In particular, the Bab el-Mandeb Strait, and southwestern Saudi Arabia, was home to a series of attacks on oil facilities and tankers about this time last year, which at one stage led Saudi Aramco to temporarily suspend its oil shipments through this route. More recently, (June 19) Western oil companies operating in Iraq fell victim to rocket attacks at the Burjesia site just outside Basra, and in May Saudi Aramco also reported drone attacks at two pumping stations along the East-West pipeline, which acts as a means to bypass the Strait of Hormuz. The United States has linked each of these attacks to Iran, whether it be directly through the activities of the Islamic Revolutionary Guard Corps (IRGC) or by way of its support of the Houthis in Yemen or factions in southern Iraq.

Photo: CSIS

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These events are not unprecedented, but it is not normal. Iranian forces have been accused of antagonizing U.S. Navy and international commercial shipping in and around the Strait of Hormuz for years. Until recently, threats—rather than violence—predominated as the means of intimidation. The last time the Persian Gulf witnessed attacks of this nature was over 30 years ago, when Iran and Iraq attacked numerous oil-bearing vessels, in what is now known as the “Tanker War.” There was some concern at the time over the risk to the continued international flow of oil, though this did not materialize in a significant way. However, as the current vice chairman of the Joint Chiefs of Staff, General Paul Selva, highlighted, the situation is very different to the 1980s in part because of Iran’s tactics but also because the United States may have difficulty in forging an international coalition for any military response.
The recent attacks are dangerous signals to international energy markets and suggest a willingness by Iran to impede international access to the Strait of Hormuz, a threat, which Iranian IRGC senior officials previously made in 2018 in the run-up to the United States reimplementation of secondary sanctions on its oil exports. At that time, Iran’s exports were still flowing freely and until May 2019 continued to do so but at a reduced rate due to sanction waivers. Now that the U.S. administration has decided to no longer permit any volumes through waivers, the incentive for Iran to keep this vital shipping lane open and free from impediments seems to have diminished in favor of illustrating their capability to disrupt flows for other exporters.

Photo: CSIS

The Strait of Hormuz is the world’s most important oil chokepoint. According to U.S. Energy Information Administration (EIA) data exports of crude oil and petroleum products through the strait amounted to 20.7 million barrels per day (b/d) in 2018, accounting for approximately one-third of world maritime oil trade (or 21 percent of global oil consumption). Some of the oil that transits the strait could reach global markets through slower and less efficient channels, but closing the strait could reduce global oil supplies by up to 15 million b/d. The importance of the Strait of Hormuz to global liquefied natural gas (LNG) markets as well should not be overlooked. Working from BP data, 25.6 percent of global LNG exports make their way through this passage primarily by way of Qatar but also from the UAE. And while maritime natural gas trade represents a relatively small proportion of global natural gas demand (with these flows only accounting for 3 percent of global consumption) the more regional and less global nature of the gas market (relative to oil), means that any disruptions to these flows could have severe energy pricing impacts for LNG dependent importers.

The vast majority of oil production in Saudi Arabia, Iraq, the UAE, Kuwait, Qatar, and Iran is exported to customers via the strait. Alternative routes to this passage are severely limited. Saudi Arabia and the UAE are the only two countries with operating bypass pipelines to get oil to port outside of the Persian Gulf. Saudi Arabia has the East-West pipeline, and the UAE maintains the Habshan-Fujairah pipeline. Combined they could accommodate an additional 3.5 million b/d or 17 percent of current Hormuz oil exports. However, even these routes have not been free from attempted attack. In May, Saudi Aramco reported two drone attacks on the East-West pipeline and a total of four tankers were sabotaged in and around the UAE port of Fujairah.

Photo: CSIS

More than 75 percent of exports that leave the strait are destined for Asia. In terms of volumes, China is the largest importer of oil from the region; however, given the size of its overall demand for oil, it is not the most reliant country on these flows. Japan, South Korea, and India are particularly dependent on these exports, with these volumes accounting for the vast majority of their imports. And even though the United States is quickly transitioning towards net oil exporter status, it still imported 1.35 million b/d via the strait in 2018.

Photo: CSIS

The above chart shows the immediate vulnerability of Japan, South Korea, and India to any potential disruption at the strait. However, given the fungibility of oil markets, the pricing impacts of an extended disruption would not be confined to these markets alone but would be felt globally. The net oil import dependence of Japan, South Korea, India, and China though, would mean that the economic impacts of an oil price shock caused by any cutoff at Hormuz would be much more severe when compared to the United States, which is nearly a net exporter and may soon become a beneficiary of higher prices. The U.S. economy, however, would not escape unscathed. The global inflationary knock-on effects caused by an oil price shock would severely limit world economic growth, which would ultimately translate into damaging effects for the U.S. economy by way of reduced demand and investment, not to mention the damaging effects that significantly higher domestic gasoline prices would cause.

While prices initially increased when news broke of the last two tanker attacks on June 13, most of this reversed by the close of the next trading day. The bearish sentiment at the time caused by oil demand concerns appeared to overpower the threat of restricted flows from the region. The most recent price increase was related to the significant draws in crude oil inventories in the United States. However, these gains also reverted on the back of growing oversupply concerns. That being said, current tensions still likely carry some form of premium in the market, but the consensus view is that tanker traffic will continue under enhanced security measures, despite recent comments by the president questioning the need for the United States to be involved in these efforts and the attendant increase in tensions for shipping.

The Strait of Hormuz and the United States

On June 24, President Trump asked on Twitter why the United States is protecting the Strait of Hormuz for no compensation. The question is based on two flawed premises. First, the United States does not, alone, patrol the waters of the Persian Gulf. Since 2004, more than 30 other countries participate in several multinational efforts to reduce piracy and preserve commercial access to international waters. The overarching organization, Combined Maritime Forces (CMF), is housed at U.S. Navy facilities in Bahrain and includes representatives of many of the 30 participating countries. Nations participating in these efforts include U.S. partners in the Gulf region, North Atlantic Treaty Organization (NATO) allies, Japan, and South Korea, among others. Second, the president’s reference to compensation in his tweet may suggest that the United States derives no benefit from its role in protecting these waterways. It is inconceivable to conclude that the United States has derived no economic and security benefit from the stable flow of oil and other commerce through the strait. Shouldering the responsibility for securing stability in the Persian Gulf alongside allies and partners has been a key tenet of U.S. foreign policy for decades not only to ensure the stable flow of oil to global markets, but also “. . . to prevent a hegemon or alignment of powers from dominating the region.
On the first point, senior administration officials in recent days have discussed the development of a program called Operation Sentinel, which seeks to create a coalition of oil-importing and exporting states to better patrol the Persian Gulf, the Strait of Hormuz, and the nearby Gulf of Oman.  According to Platts, Brian Hook, the U.S. state department special representative for Iran, will host a meeting with officials from around the world today to step up joint efforts of ensuring maritime security. Press reports so far indicate that the United Kingdom and the Netherlands have offered additional ships; India is planning to increase its presence; Spain and France have declined to contribute additional ships for fear of further stoking current tensions; and Japan is considering increasing its presence. Oil-producing states in the Gulf have offered to provide funding for the effort. As more details of the program emerge it will be important to clarify how the new Sentinel efforts align with, build on, or replace the current CMF system. The U.S. presence patrolling the Gulf is part of broader U.S. strategic posture in the region. For many reasons, that posture has been actively debated over the last several years and continues to evolve, as our colleague Melissa Dalton outlined, into one where there is more burden-sharing among regional and external partners. The emerging contours of Sentinel suggest it may be just such an arrangement.
Any coalition of forces defending the Strait of Hormuz and other regional waters will be made up of countries that are able to contribute elements of an effective force; but so far, the United States has been the glue that holds them together. This “glue” often comes in the form of providing key military capabilities that other countries don’t have—or don’t have enough of. In fact, recent comments made by the current chairman of the Joint Chiefs of Staff, General Joseph Dunford,  suggest the U.S. effort would increase presence with certain types of U.S. vessels at the Straits of Hormuz and Bab al-Mandeb, namely those that can provide command and control capability, and additional reconnaissance assets, to enable more effective multinational escort operations through these vital waterways, as allies and partners contribute additional forces of their own.
On the second point and over the long term, barring significant leadership from senior U.S. political figures, the question over whether the United States will be willing to continue patrolling the waters in the gulf will remain. Should the United States choose to step back, it is not clear whether any other state would have the capability and will to do so. Presently, only China and Russia have that capability. However, it is an open question whether either country would be willing to undertake such an effort. Moreover, if the U.S. national security strategy is to be believed, it is also unclear that the United States would be willing to cede its role in a vital global energy chokepoint to countries viewed as geostrategic rivals.  

What’s Next

Despite these recent events, the possibility of Iran successfully closing off the Strait of Hormuz for an extended period remains highly unlikely. First—regardless of the comments made by the president questioning the need for the United States to protect these waterways—any immediate and significant drawdown of U.S. military presence appears improbable given the goals of the current national security strategy and the fact that U.S. forces have bolstered in recent weeks. Second, damaging effects resulting from any cut off at the strait to numerous economies would be met with widespread international condemnation, which could quickly mobilize force to neutralize any such action. Finally, Iran itself, albeit at significantly reduced volumes, is still exporting through the strait, and its tactics to date have leaned toward plausible deniability of causing disruption rather than brazen violations of international law.
That being said, the chances of intermittent attacks in the vicinity, while tensions between the United States and Iran endure, remain high. The recent assaults should not come as a surprise. Analysts warned at the time of the U.S. withdrawal from the Joint Comprehensive Plan of Action (JCPOA) that there would be a respondent increase in regional instability around the Strait of Hormuz and in other areas in the Middle East where Iranian forces or proxies are present. Current reductions in Iran’s oil exports due to U.S. secondary sanctions, and the failure of European promises for expanded trade to materialize, mean that Iran’s incentives to build leverage by breaching the limits of enriched uranium under the nuclear agreement and through destabilizing activities like those witnessed in recent weeks have increased and are likely to continue.
The Strait of Hormuz is a strategically important transitway for the flow of energy to economies and consumers around the world. U.S. leadership of a coalition of countries to defend freedom for all lawful commerce is instrumental in maintaining this piece of the global economy and for upholding broader U.S. national security objectives. The United States abandoning its efforts in this region increases the likelihood of disrupted energy flows, increases regional rivalry between Iran and its neighbors, and creates a leadership and security vacuum in a vital artery of commerce whose protection is squarely in U.S. national interests.

Banner photo: A U.S. Navy helicopter from the USS CHANDLER and the Cypriot flagged tanker Pivot, which was attacked and set ablaze by an Iranian warship 12 December 1987 off the coast of Dubai. 
Andrew J. Stanley is an associate fellow with the Energy and National Security Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. John Schaus is a fellow with the CSIS International Security Program.
Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s). 

© 2019 by the Center for Strategic and International Studies. All rights reserved.

John Schaus

John Schaus

Former Senior Fellow, International Security Program

Andrew J. Stanley