Beyond the strait: why attacks on Kargh Island could keep oil prices high
Oil could pass 2008 record of $147.50 a barrel as damage and field closures risk compounding supply shock caused by Iran war
About 20 miles off the coast of Iran lies the source of the petrostate’s economic lifeblood and the latest target of US military aggression: an 8 sq mile coral island through which nine in every 10 barrels of Iranian crude passes each day.
The US president’s decision to launch a weekend attack on Kharg Island, the home of Iran’s processing hub and the heart of its economy, is an unsurprising counterstrike to the Iranian regime’s ongoing chokehold on the oil market’s trade artery.
But uncertainty over future oil production by one of the world’s largest producers, is also likely to cause further market volatility after weeks of historic price increases.
Donald Trump ordered the US military attack on Iran’s most strategic economic asset on Saturday, exactly two weeks after the US-Israeli strikes which began the war and led to the blocking of the strait of Hormuz.
The bombardment took aim at military assets on the island, and has so far spared oil facilities. But Trump has warned that he may reconsider if Iran refuses to open the strait.
“We may hit it a few more times just for fun,” Trump told NBC News.
Any damage to Kharg Island’s oil infrastructure could force Iran to cut production at its oilfields, potentially erasing another 1m barrels from global markets already roiled by cuts from neighbouring Gulf nations unable to ship their crude to international buyers.
Gulf oilfields forced to shut
The world’s largest offshore oilfield stretches more than 40 miles from Saudi Arabia’s eastern province into the depths of the Gulf. For almost 70 years the Safaniya field has produced millions of barrels of Arabian heavy crude to be sold by the biggest oil-producing country. This week, the field was shut.
The war in Iran has effectively blocked the Gulf states from exporting a fifth of the world’s oil supply to the international buyers through the strait of Hormuz. Iran’s attacks on tankers trapped in the vital trade route have erased an estimated 15m barrels of oil from the global market.
But beyond the tankers set ablaze in the narrow waterway just a few miles south of Iran lies a quieter threat that risks compounding the greatest energy supply shock in history and fuelling the recent surge in prices.
The risk is that the world’s biggest oil producers will be forced to shut down many of their fields altogether, keeping prices higher for households and businesses for a sustained period. In a worst-case scenario, analysts have forecast oil could pass the record $147.50 a barrel reached in 2008.
Oil producers have scrambled to redirect their crude flows to pipelines and storage facilities, but as their pipes and stockpiles reach the brim, the only option remaining is to turn off the taps. The threat to the Middle East’s oilfields is now considered the main driver for the upward march of market prices.
The price of Brent crude, an international benchmark, retreated from highs of $119 a barrel this week as global leaders prepared to call for an unprecedented release of 400m barrels of oil from its member states to temper the market. But prices have begun to inch back above $100 a barrel as oilfields in Saudi Arabia, Iraq and Kuwait have shut down.
The shut-ins – temporary closures of oil and gas wells – combined with damage to some of the region’s key energy infrastructure are expected to cut production by 10m barrels a day, according the International Energy Agency.
The war has also disrupted the world’s gas supplies. Qatar provides about 20% of the world’s seaborne gas cargoes but was forced to shut down its liquefied natural gas (LNG) production because of Iranian attacks on its facilities. In response, the price of gas in Europe rose by about 80% to highs of more than €56 a megawatt hour last week.
The Qatari energy minister, Saad al-Kaabi, told the Financial Times it would take “weeks to months” to return to normal deliveries, even if the war ended today. He said the crisis would bring down the economies of the world.
‘Months’ to fully restore output
With only days remaining in the Gulf’s crude storage facilities, and no end in sight to the Hormuz crisis, the world’s richest oil region may need to grapple with further shutdowns, according to Ajay Parmar, a director at the energy market specialists ICIS.
“The shut-ins will most certainly prolong higher oil prices – this is the main driver for higher prices that we see right now,” Parmar says. The impact is twofold: it compounds the market fears over the world’s continuing supply crisis; and raises the risk that production will remain throttled, even in the event that the strait reopens.
The process of restarting a shuttered oilfield is difficult and lengthy. It can take weeks to return a field to full production, depending on the state of the infrastructure and geology. There is also a risk that a field never fully recovers.
“Restarting field production of this scale will be a massive technical exercise,” says Jim Burkhard, the global head of crude oil research for S&P Global Energy. “Depending on the reservoir and how long it is [in] shut-in, it could take weeks, months or more to fully restore output.”
Saudi Arabia’s state-owned oil company, Aramco, has assured the market that it should be able to export 70% of its usual output to customers around the world. It plans to flow crude extracted from the Gulf more than 750 miles west across the kingdom through a pipeline to the Red Sea port of Yanbu. Saudi oil exported via this route has doubled in volume from about 1.5m barrels a day to 3m. Aramco believes this can rise to 5m within days.
Already there are at least 25 massive oil tankers en route to the Red Sea port to help ship Saudi crude to the international market, according to Aditya Saraswat, a director at Rystad Energy. Meanwhile, near the port of Fujairah, which lies to the east of the Hormuz chokepoint, tankers are ready to load crude piped around the strait from the United Arab Emirates’ oilfields in the Gulf. Its pipeline crude has climbed from 1.1m barrels a day to 1.6m this week as seaborne trade dwindled, Saraswat adds.
Parmar says the pipeline reroute options can only go so far for Saudi Arabia and the UAE. The latter will have 1m barrels of crude a day that remains unsold via its pipeline, with less than 20 days of available storage. Aramco would have 2m barrels a day unable to leave Saudi Arabia without shutting down Safaniya and the Zuluf field. It has about seven days of storage available.
“Additionally, Iraq, Kuwait and Iran itself have no pipeline capacity to bypass the strait,” Parmar added. Oil produced from Iraq’s main southern oilfields has fallen by almost three-quarters to just 1.3m barrels a day from pre-crisis levels of 4.3m. It has less than five days of storage remaining. Kuwait pumped about 2.6m barrels a day earlier this year but has made unspecified cuts to its production. It has less than 11 days of storage.
In Saudi Arabia, there are questions over whether the ageing Safaniya field, which began production in 1957, will return to its former levels of output. But Parmar cautions against writing off the engine room of the country’s oil industry. “Saudi oilfield and refining capabilities are extremely high-end and it would not surprise me if the company was indeed able to return the field back to previous capacity levels over time,” he says.