The Oil Market Shows It Can Take a Punch

So far, this isn’t your typical oil crisis.

Previous moments of tension in the Persian Gulf region, like Iraq’s invasion of Kuwait in 1990, once caused a major kink in oil supplies, igniting spikes in prices. After all, the Gulf provides around a third of the world’s oil, and much of that crude passes through the narrow Strait of Hormuz, which has recently been a target of attacks on tankers.

But this week the response in the oil markets to the tensions following Iran’s shooting down of an American drone has seemed muted — even to the surprise of some participants. Analysts say this could stem from profound changes that have occurred in oil markets in recent years.

Production in the United States has risen significantly. America has become an oil exporter, sharply reducing its purchases of oil from the Middle East, although that region remains the world’s largest source of oil overall.

Another change this time around: The world’s demand for oil is growing at a slower pace. One cause for this drop-off is that world economic growth is slowing, partly over concerns about the trade war between the two largest economies — the United States and China. But another, more permanent reason is the slow pivot away from fossil fuels as a source of energy.

Certainly, the tensions in the Gulf could escalate quickly. But oil markets have evolved, changing the calculus for risk in the region.

Oil prices have moved higher, although modestly, the last few days. The price for brent crude, the international standard, has risen about 5.8 percent since the drone was shot down, trading at about $65 a barrel Friday morning. But the recent high was about $72 a barrel in mid-May.

Oil tanker companies, worried about the safety of their crews, say they are concerned about operating in the area. With so much business coming from shipping oil out of the Persian Gulf, the companies would be very reluctant to pull out of the region entirely.

“The general area of the Strait of Hormuz represents a real and very serious risk to shipping,” Robert Macleod, chief executive of Frontline, an Oslo-based tanker company, wrote in an email. “Ships must continue to passage the area but all precautions must be put in place.”

A Frontline tankers, the Front Altair, was one of two tankers in the Gulf of Oman attacked on June 13.

Tanker charter rates have ticked up substantially over the last week, hitting about $28,000 a day for chartering the largest class of tankers. Insurance premiums for shipping in the area have also risen. If anything, though, tanker operators have been disappointed that prices have not risen even higher; in late 2018, the operators were able to charge about $50,000 a day.

“Rates have increased some, though not as much as many had thought or even hoped for,” wrote Fearnleys, an Oslo-based ship broker, in a report published on Wednesday.

Traders may be shrugging off the threat of disruptions in the Gulf knowing that a shortage could be made up by surging supplies from the United States.

A boom in oil and natural gas production in the United States in recent years, driven mainly by shale drilling, has shaken up world oil markets and revived the United States as a petroleum power. That trend is expected to continue.

Oil production in the United States grew by an extraordinary 17 percent last year, and natural gas output was up by 12 percent. In the last decade, the United States has added roughly six million barrels of oil a day, the equivalent of the combined production of the United Arab Emirates and Kuwait, two stalwarts of the Organization for the Petroleum Exporting Countries.

Canada, too, has seen its oil output surge, up 8.5 percent last year.

The explosive growth has weakened OPEC’s hold on the oil markets and cut gasoline prices sharply around the world, as supplies from the United States make their way into circulation. Under pressure, OPEC and Russia have joined forces in coordinating production cuts, but they have not been able to restore prices to the $100-a-barrel levels of 2014.

Traders know that because OPEC and Russia are keeping oil in the ground, there are large volumes of additional oil that could be unleashed on the market.

The oil market’s tame response so far to the threats of disruption has surprised some analysts. Others, though, point to fears about the world economy, and say that signs are emerging that growth in demand for oil, which had been strong in recent years, is sharply easing.

The research firm IHS Markit concluded recently that some major markets were experiencing an actual contraction in demand for oil, “the largest such decline since the worst of the financial crisis” of 2008.

Analysts say that if a weaker global economy continues to soften demand for oil, then relentlessly increasing supplies from the United States and elsewhere may swamp the markets.

“As long as growth held up, you could absorb all the growth of U.S. supply,” said Roger Diwan, vice president for energy at IHS Markit. “Now with weaker demand, the global supply growth is going to overwhelm global demand growth,” he added.

It is important to keep in mind that there has been no actual disruption of oil flows from the Gulf region.

But a major episode might well roil the markets. Analysts say that it would be very difficult to replace a large portion of the 21 million barrels or so of oil that flows through the Strait of Hormuz on an average day.

A major disruption would likely do the most damage to Asian economies. According to the United States Energy Information Administration, a government agency, 76 percent of the crude oil that flowed out of the Persian Gulf through the Strait of Hormuz went to Asian markets like China, India and Japan.

But a cutoff of supplies would not be in the interest of any of the countries in the region, including Iran, which still exports what oil it can through the Gulf. Oil provides a vital source of revenue for many governments in the region.

The United States has shown in the past that it is willing to go to great lengths to keep the sea lanes open. In the 1980s, for instance, after dozens of ships were damaged during the conflict between Iraq and Iran, navy vessels from the United States and other countries escorted tankers through the area. This time around, the United States might seek help from other oil importing countries like China and Japan.

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