Oil Geopolitical Risk Is Declining, Despite US-Iran Tensions

The recent Middle East confrontations between the U.S. and Iran has done little to permanently push up the price of oil. Oil prices spiked on the days when there were acts of aggression, but quickly retraced as the other side contained its response. Was this moderation in oil volatility the result of adept diplomacy, or is it a more structural reduction in geopolitical risk?

Oil dynamics are quickly evolving. The U.S. consumes less oil from the Persian Gulf, while countries like China are becoming an increasingly important buyer to the region. Shipping lanes have now been secured by an expanding international coalition so that the U.S. isn’t the lone enforcer. Saudi Arabia infrastructure is less vulnerable to attack as it engages U.S. military and aerial protection to intercept any missiles.

Interference in Middle East oil is now less effective in trying to derail U.S. growth, rather, it would have more of an impact on the countries with which Iran is trying to ally.

U.S. Less Reliant On Oil Imports

The U.S. is less vulnerable to Persian Gulf oil disruption than in any time in recent history, with only 12% of its crude oil supply coming from the region. The emergence of shale production over the past decade quickly transformed the U.S. to near energy independence. This radical transition is allowing the U.S. to become a net exporter of oil.

Meanwhile, China is heavily reliant on Gulf oil production with over 40% of its oil imports coming from the region. The other large Asian economies such as Japan, South Korea and India are also large off-takers of the region’s oil output. This is a critical dynamic as Iran looks to court a stronger relationship with countries like China.

The strengthening of this alliance between China and Iran was telegraphed through recent naval exercises. At the end of December, Iran’s navy took part in its first joint naval drills with China and Russia. All three benefited: Iran shows it is a credible regional power, Russia helps fortify its claim to be a power broker in the region, while China showcased its global naval reach.

The naval exercises were conducted close to the Strait of Hormuz. The location is significant: over 20% of the world’s oil is shipped through this narrow strait, making it the one of the most vulnerable choke points in the global oil supply chain.

Gulf Security Is A Global Concern

Any material interruption or blockade of the Strait of Hormuz could disrupt global growth. The U.S. naval presence in the region is there mainly to assure freedom of navigation and deter any interruptions. Over the summer, the U.S. accused Iran of attacking at least six oil vessels and, more provocatively, seizing a British-flagged oil tanker which it delayed for two months. Drone attacks on Saudi Arabian infrastructure in September were also attributed to Iran.

While the U.S. has been the key naval security cop in the region, the heightened aggression led them to expand the responsibility to a broader network. The U.S., under the auspices of the International Maritime Security Council (IMSC), recruited the U.K., Australia, Saudi Arabia, UAE, Bahrain and Albania to help patrol the region.

Japan and South Korea are also stepping up. While the two countries will cooperate with the IMSC, they will operate more independently to keep their efforts targeted. Their sensitivity is the result of the U.S. withdrawal from the U.S.-Iran nuclear deal, which many allies see as a mistake and the catalyst for the current unrest. At this point, they do not want to appear to be picking sides.

U.S. Protects Saudi’s Assets

After last September’s drone strike on its infrastructure, Saudi Arabia recruited the U.S. to provide protection. The U.S. bolstered security with fighter squadrons, Patriot anti-missile systems and High Altitude Area Defense. This firepower is a major deterrent to potential attacks as it not only has a high probability of neutralizing any damage but is more likely to be able to identify and hold the culprits accountable.

Having this in place also helped Saudi Arabia to assure investors that its oil reserves were well protected. This was essential to its Aramco IPO launch; the government’s critical equity raise.

Where Does That Leave Iran

In the past, Iranian threats to choke off the Strait of Hormuz were seen as an immediate risk to U.S. economic growth. However, that’s no longer the case. As the U.S. evolves to energy independence, the countries that are most reliant on Gulf oil are some of the ones with which Iran would like to align.

China, as already noted, is a critical oil importer and its recent inaugural display of naval cooperation with Iran and Russia is helping anoint Iran as a credible partner. Oil interruption would undermine that relationship. Therefore, Iran is quickly becoming less incentivized to weaponize oil disruption as a geopolitical tool.

The expanding naval security coalition in the Gulf and the sophisticated infrastructure protection in Saudi Arabia will make it harder for Iranian oil attacks to be effective as there are more eyes on the perpetrators.

All of that should remove some of the Middle East geopolitical risk that typically drives oil volatility. In turn, that should allow global growth and the Organization of the Petroleum Exporting Countries (OPEC)’s supply management to be the primary catalysts for any oil price changes.
Source: Forbes