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Nick Cunningham

Nick Cunningham

Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon. 

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Are Oil Markets Underestimating Iran’s Threats?

Iranian officials have suggested that they could shut the Strait of Hormuz if the U.S. moved to completely disrupt Iranian oil exports, a dire scenario that would present a supply shock to the oil market.

The prospect of an outage at the Strait of Hormuz repeatedly crops up when tensions between the U.S. and Iran deteriorate, but most analysts dismiss the idea as fanciful.

But the scenario may not be as outlandish as is commonly thought. Bob McNally, founder and president of energy consultancy The Rapidan Group, said that the U.S. is waging economic war against Iran and when a country is backed into a corner like that, “there has to be some risk that the country will lash out, even if it’s against a bigger power.”

“I think the market's a little complacent,” he told CNBC, referring to the lack of movement in oil prices following the exchange of threats between Rouhani and Donald Trump. He said that Iran has much less leverage compared to 2012 when it was enriching uranium and oil prices were much higher. With oil prices much lower, Iran’s leverage is weaker, which could lead it to take drastic measures, such as shutting the Strait of Hormuz. It’s a “credible threat,” McNally said.

Obviously, that would send oil prices skyrocketing. “When you talk about Iran's exports, that's about 2.5 million barrels per day, but if you talk about interrupting the Strait of Hormuz, that's 19 million barrels a day,” he said. “About 30 percent of...seaborne-traded oil goes through that strait. So that's a much bigger problem.” Related: Iran Vows ‘Equal Countermeasures’ If U.S. Tries To Block Oil Exports

The real pain would depend on the length of the outage. Most analysts argue that the U.S. Navy would beat back Iranian attempts to close the Strait and would manage to reopen the shipping lane in a matter of days. McNally said it isn’t that easy. “I’d be a little careful about two to three days,” he said, referring to sanguine forecasts about how quickly the Strait could be up and running again following a disruption. “If the Iranians got the jump on us, and they were able to sow mines especially, it could be several weeks before it’s safe for commercial ships to pass through.” Retired Navy Admiral James Stavridis illustrated a hypothetical scenario in which the Strait were shut in a Bloomberg Opinion column.

The Strait is only about 21 miles wide at its narrowest point, and because nearly a fifth of total global supplies passes through that narrow shipping lane, it is often described as the most significant choke point in the world.

An outage, even for a brief period of time, would be on the scale of something the oil market has never seen. And spare capacity remains very thin at around 2 million barrels per day. Worse, much of those additional barrels would need to travel through the Strait to reach the global market.

Again, the likelihood of Iran taking such a drastic action is still slim. After all, one of the biggest losers from a disrupted Strait of Hormuz would be Iran. “The country that would suffer the most from the Strait of Hormuz being cut off would be Iran. It’s a muted threat. Because it's like ‘I'm going to threaten my trade if you don't allow my trade,’” Brenda Shaffer, an adjunct professor at Georgetown’s School of Foreign Service, told Oilprice.com in early July.

Related: Oil Markets Stabilize On Major Crude Draw

But the more Iranian oil that the U.S. government disrupts, the less that Iran has to lose. Taking Iran’s oil exports to “zero,” as Secretary of State Mike Pompeo said is the objective, would be a calamity for Iran.

Still, the Trump administration faces its own obstacles that could prevent it from pursuing the belligerent course that it wants. Trump will surely be reluctant to cause an oil price spike, which would happen if the Strait were to be closed. The hesitation from American officials is clear – they have vacillated in public statements on how far they will go to disrupt Iranian supply, clearly afraid of the political fallout from high gasoline prices at home. In that sense, the U.S. may tread carefully, hoping not to provoke Iran too much, while also trying to ratchet up the pressure on Tehran. How this works in practice, and how much Iranian supply is knocked offline, remains to be seen.

By Nick Cunningham of Oilprice.com

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