The Oil Market Shrugs at Threats to the Strait of Hormuz
July 25, 2019
The oil market response to rising tensions around the vicinity of the Strait of Hormuz has been tepid to date. Examining the graphic below, we can see that prices barely budged on May 12 following the sabotage attacks on four tankers off the Port of Fujairah in the UAE. And while prices initially rose on June 13 following two more sabotage attacks in the Gulf Oman, most of those gains reverted by the end of the trading week. The downing of a U.S. drone in the same vicinity one week later appeared to have a more significant effect as it pertained to the possibility of direct conflict. However, the apparent escalation of tensions on July 18 when the USS Boxer destroyed an Iranian drone followed by Iranian forces detaining a British-flagged tanker the next day, had little additional impacts. Some have put forth demand concerns or U.S. shale as the reasons why the market is not reacting in a significant way to these events. However, this misses the underlying trend at play—that is, the market fundamentally does not believe that these are credible supply risks just yet. To date, no deaths have occurred, and tanker traffic has been “delayed” but not blocked.
The possibility of Iran successfully closing off the Strait of Hormuz for an extended period remains highly unlikely. Iran itself, albeit at significantly reduced volumes, is still exporting through the strait. And regardless of the comments made by President Trump 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. While the possibility of direct conflict breaking out between the United States and Iran is a more credible threat toward causing significant disruptions to export levels from the region, conflict remains in neither side’s interest. Iran knows full well that it would be no match and as such, its tactics to date have leaned toward plausible deniability of causing disruptions or confrontation rather than brazen violations of international law.
While rapid levels of U.S. supply growth and soft demand are undoubtedly playing a significant role in suppressing prices, the theory that they are the driving forces behind the tepid response in the market to tensions at Hormuz misses the point—the consensus view for now is that tanker traffic will continue. Whether the market is correct is another question, absent any diplomatic solution the possibility of miscalculation and conflict is likely to continue to increase.