The war in Iran has led to a worst-case scenario for the oil market: the closure of the Strait of Hormuz, through which 20% of the world’s oil flows. A prolonged closure could send international oil prices $100 a barrel, a level they haven’t hit since 2022.
The Strait, the most important oil-shipping route from the Middle East to Asia and elsewhere, doesn’t appear to be formally closed, but insurers have vowed to cancel policies for tankers traversing it. On Saturday, about 4 million barrels of crude made it through—virtually all of Iranian origin, according to JP Morgan strategist Natasha Kaneva. Normally, about 16 million barrels of crude move through the Strait a day, she writes.
Wood Mackenzie analyst Alan Gelder thinks it’s plausible that oil flows are disrupted for weeks. “During that time, oil prices are heavily risked to the upside,” Gelder said. “The most recent comparison is during the early days of the Russia/Ukraine conflict, when the fear of loss of Russian supplies drove the oil price to over $125 per barrel.” Gelder thinks $100 is on the table again. Barclays, RBC Capital Markets and Bloomberg New Energy Finance analysts also see that as a plausible outcome if the Strait remains blocked.
The market isn’t yet convinced of that scenario. Brent crude futures, the international benchmark, were trading up 6.2% late on Sunday, to $77.40 per barrel. Triple-digits are still relatively far away. Growing U.S. and South American oil exports have reduced the importance of Middle Eastern oil, and made spikes above $100 less likely than they were 15 or 20 years ago.
But the U.S. and Israeli strikes on Iran have opened up unprecedented possibilities. Kaneva says that this is the first time in modern history that the Strait has been essentially closed to all traffic. It was an outcome she had initially thought was “improbable.”
A prolonged disruption of the Strait would force countries to pull millions of barrels from storage tanks every day, and quickly force prices higher to incentivize other producers to make up the gap. There are plentiful sources of crude all over the world, but not much spare capacity that can quickly be turned on to fill the gap. The two countries that still have some spare capacity—Saudi Arabia and the United Arab Emirates—both use the strait to send their oil to customers. If the Strait is closed for weeks, Middle Eastern producers would have to start shutting in production. Kaneva expects their storage tanks to fully fill up after 25 days.
In the event of a sharp spike in oil prices, the stocks of small and heavily-indebted oil stocks would likely rise the most. That’s what happened the last time war caused an oil shock. In the first month after the Russian invasion of Ukraine in 2022, companies like small-cap Kosmos Energy and Occidental Petroleum—which had piled on debt to buy a competitor—benefited the most.
There are still several offramps that could cause oil prices to retreat. Iran and the U.S. could negotiate an end to hostilities, or Iran could choose not to disrupt energy flows permanently.
The U.S. and other countries could also circumvent an oil price increase. The U.S. Treasury has in the past provided insurance or guarantees for ships going through the strait. “If the conflict abates by Monday sundown, coinciding with the start of the Jewish holiday Purim, the oil price spike could prove short-lived,” Kaneva wrote.
Write to Avi Salzman at avi.salzman@barrons.com