The oil market shows it can take a punch

Persian Gulf tension is having an impact

Oil prices have moved higher, although modestly, the last few days. The price for Brent crude, the international standard, has risen about 5.8% since the drone was shot down, trading at about $65 a barrel Friday morning. But the recent high was about $72 a barrel in mid-May.

Oil tanker companies, worried about the safety of their crews, say they are concerned about operating in the area. With so much business coming from shipping oil out of the Persian Gulf, the companies would be reluctant to pull out of the region entirely.

“The general area of the Strait of Hormuz represents a real and very serious risk to shipping,” Robert Macleod, chief executive of Frontline, a tanker company based in Oslo, Norway, wrote in an email. “Ships must continue to passage the area but all precautions must be put in place.”

A Frontline tanker, the Front Altair, was one of two tankers in the Gulf of Oman attacked June 13.

Tanker charter rates have ticked up substantially over the last week, hitting about $28,000 a day for chartering the largest class of tankers. Insurance premiums for shipping in the area have also risen. If anything, though, tanker operators have been disappointed that prices have not risen even higher; in late 2018, the operators were able to charge about $50,000 a day.

“Rates have increased some, though not as much as many had thought or even hoped for,” wrote Fearnleys, an Oslo-based ship broker, in a report published Wednesday.

U.S. oil production can cushion disruptions

Traders may be shrugging off the threat of disruptions in the Gulf knowing that a shortage could be made up by surging supplies from the United States.

A boom in oil and natural gas production in the United States in recent years, driven mainly by shale drilling, has shaken up world oil markets and revived the United States as a petroleum power. That trend is expected to continue.

Oil production in the United States grew by an extraordinary 17% last year, and natural gas output was up by 12%. In the last decade, the United States has added roughly 6 million barrels of oil a day, the equivalent of the combined production of the United Arab Emirates and Kuwait, two stalwarts of the Organization of the Petroleum Exporting Countries.

Canada, too, has seen its oil output surge, up 8.5% last year.

The explosive growth has weakened OPEC’s hold on the oil markets and cut gasoline prices sharply around the world, as supplies from the United States make their way into circulation. Under pressure, OPEC and Russia have joined forces in coordinating production cuts, but they have not been able to restore prices to the $100-a-barrel levels of 2014.

Traders know that because OPEC and Russia are keeping oil in the ground, there are large volumes of additional oil that could be unleashed on the market.

The pace of world oil demand is slowing

The oil market’s tame response so far to the threats of disruption has surprised some analysts. Others, though, point to fears about the world economy and say that signs are emerging that growth in demand for oil, which had been strong in recent years, is sharply easing.

The research firm IHS Markit concluded recently that some major markets were experiencing an actual contraction in demand for oil, “the largest such decline since the worst of the financial crisis” of 2008.

Analysts say that if a weaker global economy continues to soften demand for oil, then relentlessly increasing supplies from the United States and elsewhere may swamp the markets.

“As long as growth held up, you could absorb all the growth of U.S. supply,” said Roger Diwan, vice president for energy at IHS Markit. “Now with weaker demand, the global supply growth is going to overwhelm global demand growth,” he added.

What if oil shipments were cut off?

It is important to keep in mind that there has been no actual disruption of oil flows from the Gulf region.

But a major episode might well roil the markets. Analysts say that it would be very difficult to replace a large portion of the 21 million or so barrels of oil that flows through the Strait of Hormuz on an average day.

A major disruption would likely do the most damage to Asian economies. According to the U.S. Energy Information Administration, a government agency, 76% of the crude oil that flowed out of the Persian Gulf through the Strait of Hormuz went to Asian markets like China, India and Japan.

But a cutoff of supplies would not be in the interest of any of the countries in the region, including Iran, which still exports what oil it can through the Gulf. Oil provides a vital source of revenue for many governments in the region.

The United States has shown in the past that it is willing to go to great lengths to keep the sea lanes open. In the 1980s, for instance, after dozens of ships were damaged during the conflict between Iraq and Iran, navy vessels from the United States and other countries escorted tankers through the area. This time around, the United States might seek help from other oil importing countries like China and Japan.