Since the US targeted Iranian nuclear facilities over the weekend, supply risks for energy markets have increased significantly amid uncertainty about how Iran will retaliate
Moving Closer Towards the Worst-Case Scenario
The bombing of Iranian nuclear facilities by the US over the weekend increased supply risks significantly for the oil and LNG market. The big question now is how Iran responds. Clearly, a major risk for the oil market is Iran now attempting to disrupt shipping flows through the Strait of Hormuz. This is a crucial choke point for global oil and LNG flows, with a quarter of seaborne oil trade moving through the strait. Roughly 20% of global LNG trade also moves through the strait.
For oil, there’s scope for some flows to be diverted. Saudi Arabia has the 5m b/d East-West pipeline, which allows for oil flows to be shipped from the Red Sea. The UAE has a 1.8m b/d pipeline to the Gulf of Oman, which avoids the Strait of Hormuz. Finally, Iran has a pipeline that runs to the Gulf of Oman with a capacity of around 300k b/d. However, with more than 20m b/d moving through the strait, a significant amount of oil remains at risk.
We could also see Iran disrupt shipments at other choke points through its proxies. Recently, we’ve seen the Houthis targeting shipments through the Bab al-Mandeb Strait.
As we have stated previously, an effective blocking of the Hormuz would lead to a dramatic shift in the outlook for oil, pushing the market into deep deficit. Spare OPEC production capacity wouldn’t help in this situation. The bulk of it sits in the Persian Gulf. So, these flows would also have to go through the Strait of Hormuz.
This would leave governments having to coordinate a release of oil from strategic petroleum reserves. Obviously, this is only a temporary solution.
Higher prices would see a boost in US drilling activity, but it will take time for this additional supply to come to market. And the volumes will not be sufficient to offset losses through the Hormuz.
Under a successful blockade, we would expect to see Brent trade up to $120/bbl in the short term. A prolonged outage (until the end of 2025) would likely see prices trading above $150/bbl to new record highs.
Would Iran Really Move to Block the Strait of Hormuz?
There are reports that the Iranian parliament has backed the closing of the Strait of Hormuz. However, the final decision lies with the country’s national security council.
While Iran may feel it needs to retaliate to US strikes, blocking the Hormuz might be a step too far. Given the potential impact on oil flows and prices from such action, there would likely be a swift response from the US and others. Also, with more than 80% of oil flows through Hormuz ending up in Asia, the impact on the region would be larger than that on the US. Therefore, Iran would want to be careful in upsetting the likes of China by disrupting oil flows.
In addition, Iranian oil moves through the Hormuz, too. Blocking the strait would have an impact on these flows.
Price action this morning suggests that the market doesn’t believe (at least not yet) that flows through Hormuz will be blocked. Brent is back below $80/bbl after briefly spiking above this level earlier in the trading session.
What Does This All Mean for Oil Prices?
While we believe a successful blockade of the Strait of Hormuz is unlikely, it’s clear that geopolitical risks have grown significantly. There are indeed supply risks for Iranian oil, given the ongoing Israeli strikes on Iran.
Therefore, we have revised our oil forecasts for the remainder of the year. We had previously forecasted that Brent would average $62/bbl in the third quarter. We’ve increased this to $70/bbl to reflect a larger risk premium. Meanwhile, we increased our fourth quarter forecast from $59/bbl to $64/bbl. Any supply disruptions would require further price revisions. It follows that, in the absence of supply disruptions, we are likely to see the risk premium fade over time.
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