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Gregory Brew

Gregory Brew

Dr. Gregory Brew is a researcher and analyst based in Washington D.C. He is a fellow at the Metropolitan Society for International Affairs, and his…

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The Most Important Waterway In The Oil World

Tensions between the United States and Iran continue to rise, with U.S. President Donald S. Trump issuing a threatening tweet against Iran’s President Hassan Rouhani amidst preparations to re-impose sanctions on Iran’s economy following the U.S. withdrawal from the 2015 nuclear deal.

The increasingly tense situation has given rise to fears of violence, perhaps even open warfare in the Persian Gulf, where one-third of the world’s oil is produced.

A key element of Iran’s strategy in such a conflict would be to close the Strait of Hormuz, the waterway through which most of the Gulf’s oil flows. Iranian officials have made several threats in this direction, in response to the escalating tensions with the U.S.

Iranian leaders frequently threaten to close the Strait, and commentators have warned that such an action is a real possibility. Iran’s military and conservative leadership, the most hardline members of its government, have rallied around President Rouhani’s threat.

Iran possesses the means to close the strait militarily, and keep it closed for several months, using a fleet of small craft, ballistic missiles and large numbers of ocean mines that would make the strait impassable. Related: Is This The Next Coal Megaproject?

Closing the Strait of Hormuz would send oil prices skyrocketing upwards. It would affect the members of the Gulf Cooperation Council (GCC), including Saudi Arabia, Kuwait and the United Arab Emirates (UAE). All three are major producers of oil and gas and depend on an open strait to access global markets.

But is Iran’s leadership really prepared to take such action? Despite the war of words erupting between Tehran and Washington, it is unlikely Iran’s government is prepared to take such a drastic step now or in the immediate future, even as President Trump appears to threaten Iran with military action. There are several reasons for this.

First, the cost to Iran’s economy could be severe, at a time when conditions within Iran are already unstable. Iran’s currency, the rial, lost 14 percent of its value against the dollar the day Trump issued his tweet. The rial has lost about half its value in the last months, prompting demonstrations inside Iran.

The United States is poised to re-impose sanctions on Iran in November, including an attempted universal embargo of Iranian oil. It is uncertain whether such sanctions will be as successful as the sanctions regime put in place in 2011, which had wide international support and reduced Iran’s oil exports by 1 million bpd. But it is certain that they will have a deleterious effect on Iran’s economy, one that Iran is unlikely to aggravate by choosing to fight a costly and, ultimately, pointless war against the GCC.

That’s the second reason why Iran is unlikely to close the Strait: it would almost certainly end badly and accomplish little in the long term. According to the best U.S. estimates, Iran has the capacity to close the Strait with mines and small naval craft for a short period. The combined military weight of the GCC, together with U.S. assistance, would obliterate Iran’s small navy and remove the mines blocking the Strait in several months, re-opening the waterway to traffic. Losses would be heavy, but there’s little doubt as to the outcome.

Third, while Rouhani and Iran’s military leadership have expressed support for the idea, ultimately the decision rests with Iran’s Supreme Leader, Ayatollah Ali Khamenei. While he supported Rouhani’s threat to close the strait, his comments were measured and relatively non-committal, indicating that he has yet to determine what course of action Iran will take.

Despite the fiery rhetoric which often emanates from Iran’s government, history has proven Khamenei to be more a realist than a zealot. He supported Rouhani’s nuclear agreement in 2015, defying Iran’s more conservative factions who opposed the agreement. Doing so constituted a reversal of his own position, held until 2015, that negotiations with the United States were useless.

Related: Is The Oil World In Panic Mode?

Khamenei has had chances to take more aggressive action. He wrote to Rouhani in 2015 that a U.S. withdrawal from the nuclear agreement would void the agreement and free Iran to pursue nuclear weapons once more. Yet Iran has vowed to remain in the agreement, together with the other signatories.

Some analysts feel a worsening economy and growing civil dissent is weakening Khamenei’s regime and could lead to the collapse of Iran’s government. But this remains unlikely, given the lack of any viable opposition forces within the country.

A cornered, desperate regime may start a war in the Gulf in order to unite the citizenry; Rouhani’s threat has already garnered him additional support from regime hard-liners, who had previously opposed him over the nuclear deal. But the situation in Iran, as well as its relationship with the GCC and the U.S., would have to get much worse before such an extreme course becomes possible.

All this might explain why oil prices barely budged after Trump’s threatening tweet, and why geopolitical risk in the Middle East tends to move prices less than it used to. Despite Iran’s economic woes, and the Trump Administration’s apparent desire to topple the regime, the situation is unlikely to deteriorate to the point that Khamenei feels force to close the Strait and trigger a war in the Gulf.

By Gregory Brew for Oilprice.com

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  • Mamdouh G Salameh on July 25 2018 said:
    Iran has threatened that if it was prevented from exporting its crude oil as a result of US sanctions, it will prevent others from exporting theirs hinting that it will stop oil shipments passing through the Strait of Hormuz.

    But there is no need for Iran to take such a drastic measure since US sanctions are doomed to fail and therefore Iran will not lose a single barrels from its oil exports for two reasons.

    One is that the overwhelming majority of nations of the world including US allies and major buyers of Iranian crude are against the principle of US sanctions in general and particularly the sanctions on Iran. They resent the tendency of the United States to slap sanctions on any country with which it doesn’t see eye to eye.

    Another reason is the petro-yuan which has virtually nullified the effectiveness of US sanctions and also provided a viable alternative to bypass the petrodollar altogether.

    Still, Iran’s threat to close the Strait of Hormuz should be taken seriously. The
    Strait at its narrowest point is 34 mile wide so it is impossible militarily to close it completely. What Iran can do is mining it stealthily with the expectation of a mine hitting an oil tanker and sinking it. Such an accident in itself would deter tankers from crossing the Strait thus causing a disruption in oil supplies until the mines are cleared. Alternatively, Iran could threaten sinking tankers crossing the Strait even if escorted by the US Fifth Navy in the Gulf. This threat might deter tanker owners around the world from sending their tankers across the Strait under pressure from global insurance companies until tension has subsided. In this way, Iran would have achieved its goal of disrupting oil supplies peacefully.

    As a result oil prices could spike steeply for a short period of time until the mines are cleared or until tensions have subsided. All the Gulf Cooperation Council members with the exception of the UAE and Oman will be affected by any closure of the Strait of Hormuz. The UAE has built a few years ago an oil pipeline with 1.5 mbd-capacity from Abu Dhabi to Fujairah on the Gulf of Oman that bypasses the Strait of Hormuz altogether. Saudi Arabia could still export up to 4 mbd through an oil pipeline traversing the country from east to west at the port of Yanbu originally built with Iraqi money to transport Iraqi crude during the Iran-Iraq war. As for Iraq, it is now totally dependent on the Strait of Hormuz for its oil exports since the Iraqi-Turkish pipeline known as the ITP transporting Iraqi oil from Kirkuk to Ceyhan on the Turkish cost on the Mediterranean is currently out of action.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London

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