Why won’t the oil flow?

Jerome Tan

After three months of near-total closure, the United States and Iran have agreed to “reopen” the Strait of Hormuz as part of a deal aimed at ending their war, only for Iran to declare it closed again. But even before the closure, why did analysts, economists, and shipping companies project the supply crisis to last long after the war’s end?

The Strait of Hormuz between Iran and the Arabian Peninsula is one of the world’s most vital waterways, with 20% of the world’s oil and gas supply moving through the strait. The war between the United States and Iran has effectively closed the strait due to the threat of ships coming under attack, resulting in a global oil supply shortage that has raised consumer prices and logistics costs worldwide.

The latest deal between the two countries extends their previous ceasefire, fully opens the Strait of Hormuz to commercial traffic, and sets the groundwork for intensive negotiations to achieve a comprehensive peace agreement. Iran’s closure of the strait has threatened the deal’s stability, yet negotiations seem to be continuing behind closed doors.

Causes of Disruption

Despite a ceasefire being in place since April 8, shipping in the strait has remained at all-time lows, with less than ten vessels transiting the strait every day compared to over 100 before the war. The failure to return to pre-war levels was largely due to the threat of Iranian strikes and ship seizures as well as an American blockade of Iranian ports following unsuccessful negotiations to fully end the conflict.

While the number of ships surged after the deal but before the Iranian u-turn, the number still falls far short of pre-war levels. Ships have remained cautious due to the possibility of undersea mines in the strait. Iran has not definitely confirmed the presence of mines, but an oil tanker association estimates that there are at least 80 mines in the strait. The strait would have to be thoroughly de-mined before transit can return to normal, which could take up to 50 days. 

Compounding the military situation are sky-high insurance premiums for ships transiting the strait, which stand at up to 4% of a ship’s cargo value compared to less than 0.25% prior to the war. This adds millions of dollars to the cost of a single journey, making passage commercially unattractive until insurance fees normalize.

Industry Cautiousness

It is no surprise then that ship owners are reluctant to immediately sail through the strait despite promises of safe passage, with major shipping companies announcing that their policy on the strait will not change for the time being. 

After previous announcements from both countries that ships could safely pass through Hormuz failed to materialize, ship operators may prefer to wait for signals that the deal will hold before transiting the strait. The latest turnaround from Iran only confirmed such worries.

This explains why there has still been little movement within the Persian Gulf, with the vast majority of ships on both sides of the strait staying put. Both ship operators and the insurance industry would like to see definite proof that clear and safe routes have been established, which would require days or weeks without incident, before moving ships out of port. Without such guarantees, ships run the risk of being struck by mines or coming under attack if the deal breaks down.

The Backlog Problem

The backlog of ships on both sides of the strait also needs to be cleared before a return to pre-war levels. At least 100 oil tankers are trapped in the Persian Gulf together with hundreds of other kinds of ships, with around 300 ships on the opposite side of the strait waiting to enter. 

A possible comparison is the 2021 Suez Canal obstruction caused by a large cargo vessel that ran aground and blocked the canal. The six-day-long obstruction resulted in a cargo backlog that took four days to clear out, and even longer before the delayed ships reached their ports of destination. Even though the disruption only lasted ten days, the sudden surge of arrivals at major port destinations led to further backlogs in unloading cargo.

In the case of Hormuz, it could take well over a month before the backlog is cleared, with another few months for ships to reach their destinations. Once the ships do arrive, major port destinations for Persian Gulf oil may struggle to accommodate the surge in ships, creating a ripple effect of delays across the global economy.

Furthermore, unlike in the Suez, there is no single authority for managing traffic in the strait. A sudden surge in ship traffic could result in blockages or accidents in the strait’s narrow maritime corridors. This is especially worrying for ship operators given that irregular or “spoofed” broadcasting of ships’ location in the strait aimed at protecting ships against hostile attack may become a cause for collision. 

Even after the backlog is cleared, global oil prices are expected to remain elevated as countries seek to replenish their oil reserves, temporarily keeping prices high. As a result, even if the situation in the strait returns to pre-war levels now, actual relief for consumers may not arrive for months, potentially being delayed until the following year.

Economic costs of delay

As the world waits for the strait to genuinely open to ship traffic, many countries continue to grapple with inflation and fuel shortages. In the Philippines, inflation has blown past the Bangko Sentral’s targets, driven by higher fuel and fertilizer costs. 

Evidently, the disruption in the last 110 days of conflict have thrown the country’s economy into crisis, but the fallout of the war will last much longer than that. Accounting for the time needed to de-mine the strait, clear the backlog at both Hormuz and ports, and the restoration of confidence in the strait’s safety, relief cannot be expected for months, if not a full year. Each unfortunate incident, whether it be a ship striking a mine, a ceasefire violation, or a breakdown in talks over the strait’s future will reset the clock and risk closing the strait once more.

Accordingly, the BSP has warned that inflation would remain above its 4% inflation target until 2027, driven by the ripple effects of continued supply shortages stemming from the Middle East, while the Department of Energy recently cautioned that it could take 6-12 months before fuel prices normalize, assuming that the conflict does not flare up once more. 

However, a return to the pre-war status quo may not even be achievable. Amidst the possibility of Iranian “fees” on passage through Hormuz and the likelihood of insurance premiums remaining high due to the region’s volatility, the promised economic relief from any peace agreement may be disappointing as oil prices remain above pre-war levels.

What’s next for Hormuz

Despite all eyes on whether both countries would follow through on their commitments outlined in the deal, it seems that the strait’s status has been set back to where it was weeks ago: uncertain and unsafe.

In the next few days, everyone will pray that diplomacy will prevail and the oil will flow, but no one should be surprised if it won’t.