Worst oil crisis could lie just ahead

OIL PRICE SHOCKS SINCE THE 1973 CRISIS

Source: The Australian

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THE threat of an Israeli attack on Iran’s nuclear facilities has pushed world oil prices up by 15 per cent in the past month and raised fears that the fissile geopolitics of the Middle East might once again spell global economic havoc.

Israel believes Iran’s nuclear program is approaching a point of no return beyond which it would be impossible to prevent it developing nuclear weapons.

US President Barack Obama is expected to press Israeli Prime Minister Benjamin Netanyahu to defer action in talks in Washington today, to give time for sanctions to have full effect.

Facing an election in November and enjoying the first rays of economic sunshine since the 2008 global financial crisis, Obama does not need a Middle East war and soaring oil prices.

However, there is a strong push in Israel for military action.

“If we do not stop Iran now, later on it will be impossible,” Deputy Foreign Minister Danny Ayalon says.

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Israel, which is understood to have its own nuclear weapons, sees a nuclear-armed Iran as an existential threat.

Saudi Arabia has indicated it would seek nuclear capability if Iran achieved it, adding further uncertainty to the stability of the world’s richest oil region.

The next three months are the most likely time for an attack as Iranian skies are clearest during the northern spring.

Iran has declared it will close the Strait of Hormuz as a first point of retaliation for any Israeli raid.

The strait is the seaway through which the oil of Saudi Arabia, Iraq, Kuwait, Iran and the United Arab Emirates is shipped.

Giant oil tankers carrying 18 million barrels of oil every day travel down the 10km-wide outbound shipping channel. This represents a quarter of the world’s oil supply and 40 per cent of seaborne oil trade.

If Iran could block the strait, it would represent a greater disruption to the world’s supplies than those that followed the 1973 oil embargo after the Yom Kippur war, the 1978 Iranian revolution, the 1980 Iraq-Iran conflict or the 1990 Iraqi invasion of Kuwait.

The International Monetary Fund has warned that the world is ill-prepared for a new oil crisis. In a paper prepared for last weekend’s G20 finance ministers’ meeting in Mexico and released on Friday, the IMF said developed countries had run down their emergency stocks while spare capacity in the OPEC countries was no more than average.

“A halt of Iran’s exports to OECD economies without offset from other sources could trigger an initial oil price increase of around 20-30 per cent,” the fund said. “A sustained blockade of the Strait of Hormuz would lead to a much stronger and unprecedented disruption of global oil supply.”

The Australian government is expressing confidence that a crisis could be managed; however, the scale of the turmoil that would flow from a Hormuz Strait closure would far exceed the government’s contingency planning.

The shock from soaring oil prices would also undermine the emerging hopes for a global economic recovery, damaging consumer and business confidence and depressing the terms of trade for oil-importing nations.

Resources Minister Martin Ferguson told The Australian that any reduction of oil throughput in the Strait of Hormuz would inevitably affect global supply.

“The possible impact on Australia will depend on a range of factors, including the length of disruption.”

He said the national energy security assessment completed last year had established that the security of Australia’s supplies of liquid fuels was “robust, with resilience enabling the market to adjust to meet demand in the event of temporary global shocks”.

However, the Australian government is as politically exposed to a new oil crisis as is the Obama administration. Already, the rising oil price is feeding the Coalition’s argument that Australia can ill afford to be introducing carbon taxes.

It will put increasing pressure on the cost of living.

If rising prices turn into a full-blown oil crisis over the next few months, the case for abandoning the introduction of the July 1 start-up for the carbon tax would become overwhelming.

Australia is far more vulnerable to an oil crisis than the level of direct imports from the Middle East would suggest.

Australia’s oil refineries, which still supply 70 per cent of domestic petroleum products, depend on the Middle East for barely 15 per cent of their crude oil supplies.

Domestic oil wells, mostly in Bass Strait, supply 20 per cent, while the balance comes from more than 20 nations including Malaysia, Indonesia, Papua New Guinea, Nigeria and New Zealand.

However, Australia also imports 30 per cent of its refined petroleum products, mostly from Singapore, which depends on the Middle East for more than 80 per cent of its supplies.

The Australian government conducted a review of its energy security late last year. The consulting firm ACIL Tasman modelled a supply disruption in which Singapore’s refineries were out of action for 30 days, depriving the region of 1.4 million barrels a day of production.

This would be similar to the effects of Hurricanes Katrina and Rita, which knocked out Gulf of Mexico oil production and US oil refining in 2005.

One of the study’s authors, Alan Smart, says the shortfall pushed up prices but this was sufficient to close the gap, with demand falling and new supplies becoming available.

“When the price spiked, the market responded very quickly with the gap filled within six days.”

The study concluded that the same could be expected were Australia to lose access to Singapore supplies, with spare capacity elsewhere in Asia quickly brought onstream.

The study found that although prices would rise by 18 per cent, there would be no interruption to economic activity in Australia.

Smart cautions, however, that a localised or regional supply problem such as a refinery shutdown, may be very different from the results of a war in the Middle East.

Singapore analyst with the oil research company Wood Mackenzie Sushant Gupta says that scenarios for a closure of the strait show a major impact on oil supplies throughout the Asian region.

“There is a high dependency on Middle East crude, not just in Singapore, with some economies taking more than 90 per cent of their crude from there.”

Gupta says the spare capacity in the Asian refining industry would be of no use to Australia if the refineries could not get access to crude supplies.

Moreover, countries throughout the region would be principally concerned to secure their own domestic supplies. Countries such as South Korea, which import petroleum but export refined products would divert more of their output to their own market.

Exports from countries such as Malaysia and Indonesia could also fall, at least as a short-term response.

Gupta says that in the event of shortages, Australia would suffer from being at the greatest distance from the regional refineries.

“All the Asian countries will be competing for the same barrels of produce from Singapore. The premium on the products will increase and the countries closest physically to Singapore will have the advantage due to freight.”

Gupta said there would be no additional supplies coming forward to meet shortfalls from Singapore, so it would be up to the market, with a spike in prices, to reduce demand.

So, although Australia currently draws the bulk of its supplies from non-Middle East supplies, the reality is that it is self-sufficient for only 20 per cent of supplies, and the market’s ability to supply the rest would be tested by an extended blockade in the Gulf.

An immediate response would be the drawdown of emergency supplies kept by all nations that are members of the International Energy Agency.

The IEA was established among oil importing countries in the wake of the 1973 OPEC oil embargo and requires all members to keep a minimum of 90 days’ supplies.

In Australia’s case, the reserves are held by the major oil companies as part of their normal commercial operations. The steady slide in Australia’s domestic oil supply has meant that Australia’s reserves are falling short of the requirement, currently standing at 88 days.

ACIL-Tasman warns that the shortfall is likely to increase over coming years; however, it is not enough to make a meaningful difference to Australia’s ability to withstand a crisis.

Ferguson retains sweeping powers under the Liquid Fuels Emergency Act to order the oil companies to give priority to essential fuel users in the event that the nation were confronted with physical fuel shortages.

It is not certain that Iran would succeed in an effort to block the strait, despite the total width of the waterway narrowing to 40km.

Many tankers were sunk during the Iran-Iraq war in the early 1980s; however, shipping technology has greatly advanced since then.

Although modern ships ostensibly make a much larger target, carrying as much as two million barrels of oil each, they are divided into sealed compartments with double-hulls and are much harder to stop or sink, even than warships.

US analysis finds that an attack on one of these vessels by three anti-ship cruise missiles would have only a 12 per cent chance of stopping it.

The same research project found Iran would have to sow a minefield with more than 1000 advanced mines, a task that would take several months, to disrupt shipping, and that would succeed in disabling only half a dozen ships.

The head of the US joint chiefs of staff, General Martin Dempsey, has said Iran would have the capacity to block the strait, but only for a short period.

“We’ve invested in capabilities to ensure that if that happens, we can defeat that.”

The US Fifth Fleet, stationed on the other side of the Persian Gulf in Bahrain, including more than 20 ships including aircraft carriers, could overwhelm the sort of “small suicide boat” attacks which the US believes Iran is planning and provides a credible support to tanker fleet.

American oil researcher Amy Myers Jaffe says it would be difficult for Iran to stop the flow of oil from the Arabian Gulf for long, if at all.

What is beyond doubt, however, is that the moment Israeli aircraft start bombing Iran, the oil price will jump. It has already risen from about $US105 a barrel to $US125 since the start of the year.

The impact on Australia has been diluted by the strength of our currency, which means wholesale petrol prices have risen by only 5.5 per cent this year, but further rises are in prospect.

An analysis by Barclays Capital suggests the oil price would rise to $US150 to $US200 a barrel in the event of an attack; however, estimates are imprecise.

As well as the loss of supply, there would be additional demand from buyers seeking precautionary stocks.

Westpac’s head of international economics, Huw McKay says the world economy remains vulnerable to oil price spikes and adds this was shown in the first half of last year when the Arab Spring pushed oil prices higher.

“That put a spanner in the works for the United States economy at a time when it had finished calendar 2010 with a bit of an upswing. When it ran into the high oil prices and then the Japanese tsunami, the US had a very underwhelming first half year.”

Mr McKay says the situation is similar, with consumers beginning to show a revival in demand. “What the US consumer doesn’t need is a fuel tax hitting them.”

The jump in petrol prices both damages consumer spending and causes an exodus from US motor vehicle industry.

Higher oil prices will also damage the economies of Asia. In several Asian economies, including India and Indonesia, government subsidies to petrol means that rising fuel prices results in a loss of control over the budget.

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