Easing Hormuz’s Grip for the Long Term

As the world remains fixated on the Strait of Hormuz, markets continue looking past it. Global markets are back near all-time highs. In Korea, where headlines warn rolling blackouts will end modern life as we know it in just weeks, local markets have recouped almost all their wartime decline. Stocks seem done (at least for now) sweating the very short term and weighing the next 3 – 30 months. Meanwhile, oil and gas producers are looking even longer-term in an effort to ensure Middle Eastern energy exports don’t depend on one nation’s whims. The real-world effect is likely outside the timeframe markets weigh, but a not-so-distant world where the Strait is mostly an afterthought is an outcome worth considering.

Exporters are already using extant infrastructure to bypass the Strait, including pipelines to Saudi Arabia’s Yanbu port and the UAE’s Fujairah port. These haven’t fully offset the Strait’s closure, and they are vulnerable to attack. But tanker traffic from these hubs outside Hormuz is up and oil and gas are sailing off to needy customers worldwide. Now the industry is likely to respond to Hormuz’s closure and these pipeline successes in a predictable manner: Expanding this infrastructure in ways that also reduce reliance on the Red Sea, where the Iran-backed Houthi militia in Yemen have also attacked tankers and cargo ships.

A fresh example hit over the weekend, when Turkey’s Hürriyet newspaper reported on a new pipeline proposal from International Energy Agency (IEA) Executive Director Fatih Birol. If built, it would link Iraqi oil to a Turkish export terminal on the Mediterranean. Turkey also wants to extend an existing pipeline to bring more oil from Iraq’s Kirkuk oil fields to Turkey’s Ceyhan port. This would route a significant amount of oil through a NATO member (with long-run EU accession ambitions), adding more stability and predictability to the market.

A Bloomberg piece translating Birol’s comments highlights the reasoning: “‘The vase has been broken once, and it’s very difficult to fix,’ Birol said, referring to the Strait of Hormuz. A new oil pipeline ‘is a necessity for Iraq and an opportunity for Turkey. It is also a major opportunity for Europe in terms of supply security. I think this should be considered a strategic project.’”^[i]

“Necessity” isn’t an understatement. Iraq typically exports 90% of its oil from its Basra port, which relies on Hormuz. With traffic effectively blocked, Iraq risks having to idle wells as local storage facilities fill. When you pause an oil well, you can’t just unpause later and expect it to gush at full capacity. As The New York Times reported earlier this month: “The pressure underground can get out of whack while wells are closed; water can build up. If the shutdowns last a long time, equipment might corrode after being exposed to hydrogen sulfide for too long. The toxic gas, which smells like rotten eggs, is often found mixed in with oil and natural gas. Saudi Arabia and Iraq inject gas or water into many of their wells to coax out more oil, adding another layer of complexity to re-establishing the correct pressure when the time comes to reopen, the research firm BloombergNEF wrote recently.”^[ii] In other words, Iraqi oil producers aren’t just losing exports now, but they are storing up high restart costs and lower revenues as things get rolling again.

Moving away from the Strait long-term would give producers there (and throughout the Middle East) the transit certainty they presently lack. Not only would that support supply in the long run, but it might also remove some of the risk premium the Strait’s delicate conditions add to prices. You may end up with a world that has more and cheaper oil long-term.

Again, this is all too far out for markets to price today. The proposed pipelines require political agreements among participating nations first. Then comes all the mapping, permitting and land acquisition, followed by a couple years of construction. We are looking at a multi-year process well beyond markets’ 3 – 30 month view. But when headlines remain hung up on worst-case scenarios, it helps investors to fathom all the ways those might not come true, even if they are distant. Seeing a bright future can help you avoid making knee-jerk moves in fear of the worst now.