Oil markets are giving us a false sense of security

The longer the war lasts, the thinner our energy safety net gets

Global oil markets have proved remarkably resilient during seven months of war in the Middle East. But that resilience may be giving consumers a false sense of security.

Oil is still reaching world markets despite severe disruption to the Strait of Hormuz and the Sept. 11 attack on Saudi Arabia’s East-West pipeline. Prices are high, but they have not reached the levels many feared when the war began on Feb. 28.

The stakes are enormous. Before the war, about 20 million barrels of oil and other petroleum liquids passed through Hormuz each day, equivalent to roughly one-fifth of global consumption. Few practical alternatives exist for moving that much oil out of the Persian Gulf.

So the fact that oil continues to reach world markets does not mean the global oil system has comfortably absorbed the shock. The world is using many of the safeguards available to keep the oil flowing, leaving fewer options if another major disruption occurs.

When shipping through the Strait of Hormuz was disrupted, Saudi Arabia relied heavily on its East-West pipeline to move crude from its eastern oilfields to Yanbu on the Red Sea coast. The United Arab Emirates similarly relied on its pipeline carrying crude from Abu Dhabi to Fujairah, outside the strait.

Saudi Arabia and the UAE are better placed than most Gulf producers because they have pipelines capable of carrying substantial volumes of crude to terminals outside Hormuz. These routes helped prevent a much more serious supply shock, although they cannot replace all the oil normally shipped through the strait.

But the vulnerability of relying on these alternative routes became clear when Saudi Arabia’s East-West pipeline was attacked on Sept. 11. The pipeline has capacity to carry about seven million barrels per day and had been moving roughly 5.5 million barrels per day before the attack.

Saudi Arabia has since resumed operations on the East-West pipeline and tanker loadings at Yanbu, easing some of the immediate pressure. But the episode exposed an uncomfortable reality: alternative routes provide protection only as long as those routes remain operational.

With oil flows to Yanbu disrupted, Saudi Arabia and other Gulf producers were forced to turn once again to the Strait of Hormuz. Ship operators willing to accept the risk have been using a U.S.-supervised corridor near Oman, and Gulf producers have increasingly relied on that route since the attack on the Saudi pipeline.

Analysts estimate that six million to seven million barrels per day are now moving through this southern route. Combined with about two million barrels per day moving through the UAE pipeline to Fujairah, roughly eight million barrels per day of the 15 million barrels disrupted at the beginning of the war have been restored, leaving about seven million barrels per day still missing from prewar flows.

U.S. Central Command says American forces have assisted 2,000 commercial ship transits carrying more than one billion barrels of oil from Gulf producers in recent months.

Military-protected tanker traffic has helped prevent a severe supply shortage. But when commercial tankers require military assistance to move crude through one of the world’s most important energy corridors, the oil market is hardly functioning normally.

Existing oil inventories have helped make up some of the difference. About 3.5 million barrels per day are being drawn from inventories around the world, while China has relied heavily on its own stocks and bought less crude than usual on international markets.

These inventories can stabilize markets today, but every barrel used leaves less available to deal with another supply shock until stocks are replenished.

Higher prices and sluggish economic growth have also reduced global demand, while producers outside the region, including the United States, have added hundreds of thousands of barrels per day of additional supply.

Put all these factors together and the reason oil prices have not skyrocketed becomes clearer. The market has compensated for disrupted Middle Eastern oil traffic through existing inventories, alternative pipelines, additional production, risky tanker movements and lower consumption.

The global oil system has proved remarkably flexible, but each of these responses has limits.

Oil inventories cannot be drawn down indefinitely. Lower demand caused by high prices and weaker economic growth comes at a cost. Tankers moving through a conflict zone face higher insurance and transportation costs. Alternative pipelines can themselves be attacked. And additional production elsewhere cannot necessarily be increased quickly enough to compensate for another major loss of supply.

China is already moving to protect domestic supplies. Chinese refiners have suspended most fuel exports for October as the country seeks to preserve domestic inventories depleted during the crisis.

That matters because countries relying on inventories and other emergency measures will eventually have to protect what they have left.

Another successful attack on critical oil infrastructure, a further reduction in tanker traffic through Hormuz or another major loss of Middle Eastern production would therefore hit a market with fewer options available to cushion the shock.

Seven months of war have demonstrated the resilience of the global oil system. Existing inventories, alternative pipelines, additional production, risky tanker movements and weaker demand have kept enough oil moving to prevent the crisis many feared.

But these measures have limits. The longer the conflict continues, the more difficult it will become to absorb the next serious supply shock.

Toronto-based Rashid Husain Syed is a highly regarded analyst specializing in energy and politics, particularly in the Middle East. In addition to his contributions to local and international newspapers, Rashid frequently lends his expertise as a speaker at global conferences. Organizations such as the Department of Energy in Washington and the International Energy Agency in Paris have sought his insights on global energy matters.