Alternative routes to the Strait of Hormuz

3.4Alternative routes to the Strait of Hormuz

Figure Oil pipelines

The potential capacity of the alternative transport routes is indicated in Table . The pipeline from Abqaiq to Yanbu (East-West or Petroline) has a nameplate capacity of 5 Mb/d and consists of two lines. It has been reported that only one of the lines remains in service for oil. The other line has been converted to natural gas and would not be readily available for oil transport. The estimated capacity of the line in use is between 2.5 Mb/d and 3 Mb/d. As utilisation on this line is estimated at 1.5 to 2 Mb/d, our working assumption is a spare capacity on this line of 1 Mb/d. If the closure of the Strait were to occur today, the other pipelines would not be available for use, for the reasons indicated in the footnote to Table . In addition, shipments from Yanbu add up to five days roundtrip travel time for tankers through the Bab al-Mandab Strait to major customers in Asia

Table Capacity of alternative oil transport routes in the Middle East

Alternative transport routes	Barrels/day
Iraq-Turkey pipeline1 and Strategic Pipeline2	2,300,000
Iraq-Syria-Lebanon Pipeline (ISLP)3	700,000
Iraqi Pipeline through Saudi Arabia (IPSA)4	1,650,000
Saudi Arabia East-West pipeline (Petroline) to Yanbu on Red Sea	5,000,000
Trans-Arabalalian Pipeline (Tapline) from Saudi Arabia to Zahrani on Lebanese coast5	500,000

Notes:

¹Usable capacity in 2007 believed to be 300,000 b/d.
² System needs rehabilitation.

³ Flows stopped in 2003 due to war.
⁴ Needs to be reactivated; currently carrying natural gas.
⁵ Capacity in 2007 was 50,000 b/d.

Source: http://www.marcon.com/marcon2c.cfm?SectionListsID=93&PageID=771.

According to advice from the IEA, around 2 Mb/d of crude oil could be shipped through the East West Pipeline if a disruption had occurred on 1 March 2012 resulting in a loss of 15 Mb/d, after allowing for additional production from the region.

3.5Conditions leading up to closure

Changes to speculative demand for crude oil refer to buying or selling of oil in response to “expectations shifts”. These shifts involve changes to perceptions of uncertainties relating to future supply and demand and consequential prices. Changes in speculative demand cause oil price changes.

A major issue is that speculative demand derives from precautionary, hedging, investment and pure speculative activities, which are now focussed mainly in futures or derivative markets, not spot markets. Oil futures were first traded in 1983. Activity in futures market has increased greatly over the past decade, particularly from 2005 (Hamilton, Wu, 2011).

The causes and consequences of precautionary buying and other speculative demand are discussed at length in Section A.2 of Appendix C. If the futures market is in contango (futures prices exceed current spot prices) and the spread is large enough to exceed crude oil holding costs (storage and interest cost) – a case of strong contango – there would an incentive to sell oil forward and to purchase crude oil on the spot market and hold it for delivery under the forward contract. Alternatively, a producer could slow production, which means higher remaining underground reserves (a form of inventories). Therefore, arbitrage activity could be expected to lower futures prices and increase spot oil prices, moderating the spread.

This strong link between futures and spot markets does not exist if the futures market is in backwardation (current spot prices exceed futures prices) or weak contango (futures prices exceed current spot prices, but not sufficiently to cover crude oil holding costs). It is not possible to buy crude oil in the futures market and then sell at an earlier time in the spot market (Tilton, Humphreys, Radetzki, 2011).

However, there is a weaker mechanism through which the futures market can still influence the spot market during periods of backwardation and weak contango. Users of crude oil are prepared to bear costs of holding inventories of crude oil up to some level because having stocks on hand reduces risks of supply disruption and delays in acquiring additional supply to respond to a demand surge.

In the lead up to 1 March 2012, the futures market was in slight backwardation. However, despite this, there appeared to be a strong incentive for users to build inventories to reduce risk of supply disruption.

These factors created an environment for precautionary buying in the crude oil market by refineries in Europe searching for replacement grades for the heavier Iranian crudes and by stock building by Chinese oil refineries². This, reinforced by increased demand for Brent crudes from Asian oil refineries, led to a gradual rise in Brent and Dubai crude prices. Price rises in West Texas Intermediate were less marked owing to high inventory levels at Cushing Oklahoma storage depot, that were expected to be drawn down for technical reasons in the following months.

The trend of increasing in crude oil prices accelerated in the first quarter of 2012, as shown in Figure . The prices of Dated Brent and Dubai crude oil increased by around 13 per cent during this period³. The percentage increase in West Texas Intermediate crude oil was of a similar order, although for the above mentioned reasons, its price was lower.
Figure Movements in physical crude prices and crude futures ($/bbl)

Data: IEA, April 2012.

Not all of this price increase can be attributed to concerns about the potential supply shortfalls associated with a disruption to shipments through the Strait of Hormuz. However the IEA reported that prices fell in March by around $5 per barrel “on cautious optimism that the stalled talks with Iran over its nuclear program would resume” (IEA, April 2012). This suggests that speculative buying driven by concerns over a possible incident with Iran may have pushed the price of crude by up to $5 per barrel in February. Precautionary buying appears to have contributed to a further increase bringing the total increase to around $9 per barrel over the period from the beginning of February to the beginning of March. This can be seen in Figure .

As discussed above concerns over supply disruptions in Syria, South Sudan and Yemen had been a factor in the elevated oil prices over the previous eleven months. Concerns over conflict with Iran had also been a factor but it is not known how much of a factor they had been. Spot prices for dated Brent had been moving in a narrow range around $110 per barrel since October 2011. The Brent price began a steady rise in early February. This is more likely to reflect concern building in the market over the Iranian situation and the growing concern about shipments through the Strait of Hormuz. While there were some concerns over Iran prior to the beginning of February 2012, ACIL Tasman has assumed for the purpose of economic modelling for this report, that the price rises attributable to speculative buying in contemplation of closure of the Strait of Hormuz began in February.

Global oil demand hit a peak in February of 91.1 million barrels per day (Mb/d) compared to an average demand of 89.1 Mb/d for 2011. Global supply fell by 0.2 Mb/d to 90.4 Mb/d in February 2012 with rising OPEC natural gas liquids production only partially offsetting a 0.5 Mb/d decline in production from non-OPEC countries.

Production from Iran declined by 50 kilo barrels per day (kbd) to 3.38 Mb/d compared with a sustainable production capacity of 3.51 Mb/d. A number of European countries had reportedly halted imports from Iran but this was reported to be offset by increased purchases from Asian countries including India and South Korea (IEA, April 2012).

OPECs spare capacity declined to around 2.54 Mb/d from 2.75 Mb/d in February 2012 reflecting in part the removal of Iranian spare production capacity on the basis that sanctions would progressively cap the ability of the country to raise output. Overall it appears that there was a supply shortfall in February equivalent to around 700 kbd, which was met from stocks. This was predominantly at the expense of OPEC stocks as OECD and some Asian refineries increased stocks over the period.

Concerns over closure of the Strait appeared to abate in late February and early March. If closure had occurred on 1 March it is likely that market concerns would have increased in late February leading to more precautionary buying which would have increased the price above the $9 per barrel cited above. Further discussion of the magnitude of the price rise in the period leading up to a closure is discussed in Section 4.3.