Oil: The Strait Of Hormuz And Why It Is Important

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Includes: OIL, USO, UWTI
by: Nicholas Bodnar

Summary

The Saudi's and their allies recently attacked rebels in Yemen. This led to a fast price appreciation in oil future due to a potential disruption of supply.

The Strait of Hormuz has 17 million bopd or 30% of the oil transported on the maritime routes traveling through it daily.

Rebels in Yemen are connected to the Iranian Government which could lead to trouble down the road via the transportation of crude oil on the Strait of Hormuz.

On March 26, 2015 the Saudi's and their allies attacked the rebels in Yemen via airstrike. In this attack there were over 150 jets, 100 from the Saudi's, 30 from the United Arab Emirates, 15 from Kuwait, 15 from Bahrain, 10 from Qatar and a few from Jordan. There was also naval help from Pakistan and Egypt. The rebels or more precisely the Houthi rebels, are Shiite Muslims that have recently taken over the Yemen capital of Sanaa and taken over parts of the largest city; Aden. This is relevant due to the fact that the Saudi's consider the Houthi rebels are proxies for Iran. Following the attack, oil futures jumped 5% in one day, the biggest gain in a month. The gain was due to fear that supply could be disrupted via important choke points; the Strait of Hormuz and Bab el-Mandeb.

Source: Vacations to Go

The Strait of Hormuz runs on the Persian Gulf between the United Arab Emirates/ Oman and Iran. While the Strait of Bab el-Mandeb runs on the Red Sea between Yemen and Erithera/Djibouti. With Houthi rebels taking over parts of Aden, the Strait of Bab el-Mandeb, has potential of becoming disrupted. The biggest threat is that Iran may become threatened from this attack and the Strait of Hormuz will become disrupted, lowering the potential supply of oil to the world markets.

Why the Strait of Hormuz is Important

Around 63% of the world's oil supply that moves on maritime routes. The most important maritime route for oil transit is the Strait of Hormuz. With around 17 million barrels of oil moving through the Strait of Hormuz per day, a blockage in the strait could prove to disrupt the supply of world oil.

A chokepoint is defined by the EIA as narrow channels along the widely used global sea routes. Some of these routes are so narrow that there are restrictions in place that limit how big the vessels are that are allowed to travel through the route. Oil that is shipped via the Strait of Hormuz was 30% of all seaborne oil in 2013.

When a chokepoint is blocked, temporarily or for an extensive time, energy cost and world energy prices rise. Even if the chokepoint is not blocked, there is a risk of terrorist attacks, theft from pirates, and other hostilities. The narrowest point through the Strait of Hormuz is 21 miles wide, with the shipping lanes only 2 miles apart on either side due to buffer zones. The picture below shows the Strait of Hormuz and an Iranian soldier.

Source: The London Evening Post

The volume of crude oil and other petroleum products that were transported through the Strait of Hormuz were; 15.7, 15.9, 17.0, 16.9, 17.0 million bopd in; 2010, 2011, 2012 and 2013, respectively. There have been a number of disputes in or in regards to the strait. These disputes are summarized in order from date below.

April 18th, 1988: A one day battle between the U.S Navy and Iranian forces in the strait and around the strait. The name of the battle was called "Operation Praying Mantis".

July 3rd, 1988: A passenger jet was shot down by the United States Navy that killed 290 people. The jet was an Iran Airbus A300.

January 8th, 2007: A US nuclear sub struck the MV Mogamigawa, a 300,000 ton Japanese crude tanker. There were not any injuries and crude oil did not leak into the strait.

Around 2008: A standoff between US warships and Iranian speedboats. There were no gun fight only allegations against each political party.

June 29th, 2008: An official from Iran said that if Iran was attacked by Israel or the United States, then they would block off the Strait of Hormuz. The Iranian goal was to wreak havoc in the oil markets.

March 20th, 2009: A US submarine collided with a transport dock. There were 15 sailors injured and a ruptured fuel tank that resulted in the spill of 25,000 gallons of marine diesel fuel.

2011-2012: An official from Iran threatened to cut off the supply of oil if economic sanctions limit or cut off Iranian oil exports. There were other threats that happened due to US battleships getting close to Iran due to the protection of maritime commerce. Finally other threats happened due to the European Union imposing sanctions on Iranian oil.

Alternatives to the Strait

There are pipelines that can transport oil to bypass the Strait of Hormuz, but some of these pipelines are not operational. The unused pipeline capacity is estimated to be 4.3 million bopd. The capacity of all of the operating pipelines that bypass Hormuz is 8.2 million bopd, yet the unused capacity is 3.7 million bopd. This leaves a measly 2.9 million bopd of oil that can bypass the strait daily. The big question is where does the other 14 million bopd go? If the strait was blocked temporarily, the supply of oil would be disrupted leading to an increase in the price of crude oil.

Market Effects from Iranian Fears

There are stock ETNs and ETFs that are expected to have heavy volume from these Saudi attacks and fears from Iran. The United States Oil ETF (NYSEARCA:USO) and the iPath S&P GSCI Crude Oil Total Return Index ETN (NYSEARCA:OIL) is the perfect example. Following the attacks, the USO posted solid gains in amidst of continued fears of lower supply in the future. The actual gains from Thursday's attack on the USO were 4.8% with over 33 million shares trading hands. Gains from OIL were 5.2%. A highly leveraged ETN, VelocityShares 3x Long Crude Oil ETN (NYSEARCA:UWTI) went up more than 14%. If the Strait is in danger of becoming blocked, investors should expect these ETF's and ETN's to skyrocket in price.

March 27th, 2015

The next day after the attacks the price of crude oil settled down 5%. The shipment conflicts eased and talks of the likelihood of an Iran nuclear deal by next week is believed to put more of a supply of oil on the market. USO was down 5.88%, OIL was down 6.31% and UWTI went down 17.20% on Friday, wiping out all gains from the day before.

Conclusions

If nuclear actions are affected by this conflict with the Saudis and Iran, investors should keep an eye on the rise of oil. If nothing happens because of the conflict, a nuclear deal may be passed bringing and even heavier supply of oil to the world markets. There are some oil analysts who believe that this attack will not do much to the broader oil market. What we do know as true, is if the Strait of Hormuz is blocked, even temporarily, there will be a fast price appreciation in the price of oil.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.