How the Bab al-Mandab blockade threat helped push oil back above $100

Summary

A fresh front in the Middle East crisis opened this week, bringing a return of soaring global energy markets and stoking fears that the oil price could surge to $120 a barrel. In a matter of days the price of Brent crude has jumped by more than 13%, breaching the $100 a barrel mark on Thursday after Yemen’s Houthi militias took aim at a new target: Saudi oil exports via the Bab al-Mandab strait. The development comes as the tentative recovery of shipping through the strait of Hormuz, which had helped oil prices to return to pre-crisis prices of as low as $71 at the start of the month, grinds to a halt amid the breakdown of the US-Iran ceasefire. Any disruption at Bab al-Mandab, the narrow waterway between the Arabian peninsula and the Horn of Africa, would threaten one of the few remaining routes for Gulf oil exports to circumvent the Hormuz blockade, warned Jorge León, head of geopolitical analysis at Rystad Energy. “If a ceasefire does not materialise and Hormuz remains largely closed while the Houthi threat to Red Sea shipping intensifies, the risk of a significant rebound in oil prices would be substantial,” he said. What has happened? The latest escalation began with the Houthis sending out an email to shipping companies on Monday warning them not to load and unload at Saudi ports or else face being targeted “in any location” within its reach. The Tehran-allied group, which controls Yemen’s capital and its north-western territory along the Bab al-Mandab, reiterated its threat the following day, claiming that at least six ships had changed course as a result. The trade route through the southern entrance to the Red Sea carried about 4.1m barrels of crude oil and refined petroleum products each day last year, or roughly 5% of the global total compared with the 20% of global oil supplies that once transited the strait of Hormuz. But in the months since the US-Israeli surprise strikes on Iran at the end of February, volumes through Bab al-Mandab have surged as the channel has become a vital alternative export route for Saudi Arabia’s vast crude volumes. Riyadh began to reroute oil via a pipeline from its Abqaiq processing plant, near the Gulf, to the Yanbu export terminal on its west coast, effectively channelling about 75% of its usual exports to the global market via the Red Sea. Rystad Energy vessel-tracking data indicates that approximately 2.5m barrels a day of these Yanbu volumes are currently moving south through Bab al-Mandab and on to customers in distant markets such as India and China. Traffic through the strait collapsed during the Gaza war when Houthi strikes on vessels near the waterway, launched in support of Palestinians in Gaza, caused many of the world’s largest shipping companies to use alternative routes. They were understood to be considering a return to the trade route this summer, almost three years after the initial disruption began, but the escalating Gulf crisis has laid waste to such plans. What does this mean for oil prices? Since peace talks between the US and Iran broke down and Trump declared the ceasefire “over”, the Brent crude benchmark has climbed by more than a quarter to over $100 a barrel, putting the market on track for its largest monthly gain since March – the first month of the Hormuz blockade. Washington is still insisting the strait is open even though transits have slowed to a trickle amid strikes by both sides on each other’s maritime traffic through the channel. Meanwhile a senior Houthi official warned this week that its policing of Saudi crude exports via Bab al-Mandab would cause oil prices to “skyrocket to $200 a barrel in a dreadful shock” for the market. In a video statement this week, a Houthi military spokesperson described it as an “equation of ‘an eye for an eye’” after accusing Riyadh of breaching a four-year ceasefire earlier this month. In response, Saudi Arabia’s military has warned that all Houthi threats against transiting vessels would “be dealt with swiftly and firmly, as such threats are a blatant violation of international law and fall under acts of maritime piracy”. Still, the Houthi threats have taken a toll on the market. At least five Saudi-linked oil tankers bound for Bab al-Mandab turned back as Houthi blockade threats picked up, according to maritime intelligence data from Windward, of which four were carrying Saudi-origin cargo. In addition, an oil tanker destined for China is understood to have reversed course after leaving the Red Sea port of Yanbu to transit the strait. The danger posed by not turning back is high. On Thursday the Houthis said they had hit two Saudi tankers, with a Riyadh news agency later confirming that one was ablaze. Yet changing course comes at a steep financial cost. Full avoidance of this waterway, through which a quarter of global container trade passes on its way to and from the Suez canal, requires rerouting around Africa via the Cape of Good Hope. That journey roughly doubles the voyage length and adds an estimated $2m-$2.5m in cost for each transit. This helps explain why some owners keep running the risk, according to a Windward report on Bab al-Mandab traffic on Tuesday. It recorded three Saudi-linked oil tankers continuing towards the strait despite the Houthi warnings, while another three nearby turned off their transmitters in response to the threat. What about road fuels and gas? The pressure on crude oil supplies in the global market is only part of the problem, according to the head of the International Energy Agency. Fatih Birol warned this week that many refineries had reduced their production of fuel products, including transport fuels such as diesel, to avoid the surging cost of crude. Although the lower oil demand from refineries has helped to keep a lid on oil market prices, it has created even greater stress on global fuel supplies. Even as Gulf crude exports increased during the US-Iran ceasefire, the production of road fuels has remained weak, Birol pointed out: “Refinery activity and product supplies have not picked up as much as crude deliveries, meaning that markets for refined oil products, including diesel and gasoline, are considerably tighter than those for crude.” Goldman Sachs has said global supplies of diesel have been under pressure regardless of the resumption of US-Iran hostilities, owing to the market’s high exposure to refinery outages in the Middle East and especially in Russia, where Ukrainian drone attacks have reduced refining capacity by 80%. “Just three weeks ago we were celebrating the biggest ever monthly drop in the price of diesel,” Simon Williams, head of policy at the UK motoring group RAC, said this week. Now, he said, fuel prices are “shooting up like a rocket”. The average price of diesel on British forecourts has climbed by almost 8p, or 5%, to 172.14p a litre in the past fortnight, while petrol has risen by 5p in two and a half weeks to 155.57p, a 3% increase. There are worrying implications for global gas supplies too. While an increase in gas exports from the US and Canada helped to offset about 70% of the lost Gulf supply via Hormuz, availability is expected to remain tight in the run-up to winter as European buyers attempt to refill depleted gas storage facilities, Birol said. Clémence Dubois, head of global campaigns at the green group 350.org, said: “One of the world’s critical choke points remains closed as attempts to reopen it have failed. Now, we see a second critical choke point on the knife’s edge. That should terrify anyone who still thinks fossil fuel dependence is a safe bet. “It shows just how fragile and dangerous our dependence on oil and gas really is,” Dubois added. “Those shocks travel straight into food, fuel and transport costs, hitting hardest in countries with the least fiscal room to absorb them, while fossil fuel companies reap insane profits.”