War with Iran: how to get the oil flowing again

At a guest lecture at the UT Energy Symposium last Wednesday night, Amy Jaffe of the Baker Institute challenged the audience to imagine what a global oil shortage would look like, and how it would drastically change our day-to-day lives. Such a scenario has become increasingly relevant this year as the US and Europe tighten economic sanctions on Iran and Israel signals that it is preparing an airstrike on the country’s nuclear facilities. Iran has made clear that it will answer any attack with the one high card it holds: closure of the Persian Gulf’s narrow entrance, the Strait of Hormuz, with mines and attacks on oil tankers. That would immediately take 17.8 percent (17 million barrels per day) of the global oil supply and a third of liquefied natural gas (LNG) off the world market, leading to price spikes and/or fuel shortages around the world.

Most news reports stop there, assuming oil suppliers would have to wait for the US Navy before oil would start flowing again. However, both the Gulf Arab suppliers like Saudi Arabia and consuming countries have several tools of their own to balance the world oil market. Here’s how it would likely play out:

  1. At the start of the conflict, the Paris-based International Energy Agency, comprised of the US, Japan, Canada and Europe, would immediately co-ordinate a release of oil from strategic reserves. The IEA claims its members could sustain releases of 17 million bpd for 30 days, though western countries would be loath to run down all of their reserves. A more likely scenario would be releases of 6-10 million bpd (or about 50 percent of the global short-fall) for the first week or two of the conflict.
  2. Saudi Arabia would divert oil into its fully functioning East-West Pipeline (Petroline), sending about 3.5-4 million bpd of additional oil to ports on its west coast, cutting down on 20 percent of the shortage.
  3. If the conflict occurs more than two months from now, the United Arab Emirates would be able to activate its own newly constructed Fujairah pipeline (ADCOP) to the Indian Ocean. The pipeline will have a capacity of 1.5 million bpd, cutting down on 9 percent of the shortage.
  4. Saudi Arabia would scramble to re-commission a second pipeline to its west coast, the IPSA route, which has been dormant since the first Gulf war. Estimates vary on how long it would take to get the pipe up and running, but it remains in good condition. The pipeline would be able to take a little over 1.5 million bpd, cutting down on another 9 percent of the shortage.
  5. In the event of a longer conflict, in which the Iranians put up greater-than-expected resistance, Saudi Arabia could implement a crash project to raise the capacity of the East-West pipeline with additional pumping stations and the injection of chemicals (DRAs) that speed the flow of crude through the pipe. Dagobert Brito of the Baker Institute has estimated that such a program could raise the capacity of the pipe by between 1.8 and 2.6 million bpd at a cost of several hundred million dollars if completed in peacetime. That would cut down on another 10-15 percent of the shortfall. But it’s unclear how long this would take to complete during a war.

Make no mistake about it: a closure of the Strait of Hormuz would be a shock to global energy markets. Gasoline could easily rise above $6, even $7 a gallon, and there would be no way to replace the LNG. However, with the first three measures outlined above, consuming countries and the Arab Gulf states could, with good co-ordination, make up 78-82 percent of the short-fall within days. With crash programs to implement the final two measures, Saudi Arabia could even close the short-fall entirely, allowing the consuming countries to ratchet back their use of reserves. Of course, this analysis excludes the possibility that Iran rains missiles down on Saudi Arabia’s oil fields and processing facilities. In that scenario, we just might be out of luck.

REFERENCES

Brito, Dagobert. “Re-visting alternatives to the Strait of Hormuz.” James A. Baker III Institute for Public Policy: January 2012. Available for free download here.

Stevens, Paul. “An Embargo on Iranian Crude Oil Exports.” EEDP Program Paper: January 2012. Available for free download here.

US Energy Information Administration. “World Oil Transit Chokepoints.” Last updated December 30, 2011. Linked here.

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1 Comment

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One response to “War with Iran: how to get the oil flowing again

  1. ghasemidoroh

    Thanks for your topic.
    In my opinion, Iran’s policy for closing the strait of Hormuz is not 100% clear. We should consider that even though some politician in Iran may say that they are going to close the strait of Hormuz, those are not guaranteed to be executed. The final decision is made by the supreme leader (Ayatollah Ali Khamenei)
    Furthermore, let’s assume that Iran closes the strait of Hormuz. Iran now is experiencing bad economic conditions because of many sanctions and is struggling with them. Also keep in mind that Iran’s economy is mostly based on oil exports. Hence it is very important for Iran to sell its oil. If Iran closes the strait of Hormuz, then eventually it can not sell its own oil as well and in the current economic conditions of Iran, they would avoid this.
    Last, Iran always has tried to keep a good relation with its neighbors specially Saudi Arabia. Because of a religious gathering which happens in Saudi Arabia, Iran tries to keep its good relation with Saudi . Also Iran does not want to lose its repetition between those counties with whom Iran has a good relation. Consequently, Iran’s international policies would not let them to close the strait.
    We may ask if they will not close the strait, why they say this time to time? The answer would be easy ! Think of two boys fighting with each other. Both sides threatening each other with many stuff which they never do ! 🙂

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