Quarterly Market Update
Oil and the Musandam Peninsula
The Strait of Hormuz with its calm waters swimming in dolphins is probably the world’s most important oil chokepoint – almost 17 million barrels per day move through the Strait. Bypassing this deceptively peaceful body of water, should the situation with Iran escalate to the point where the Strait will be closed down, could add an additional cost for transportation.
Before you read ahead, look at this picture and try to guess where it was taken? Gibraltar? Greece? Cyprus? Or maybe the Strait of Hormuz?
If you picked the last location, congratulations! You should probably join a geographical mapping service! Indeed, it is hard to imagine that the calm waters of the Strait, depicted here, where dolphins swim gladly following a few Omani dhows, is the recent cause of such controversy, fear and speculation. Before we delve into the core of the issue, as it relates to oil prices1, a little context may be useful.
The Strait of Hormuz (shown circled on the inset map) is located between Oman and Iran. It connects the Persian Gulf with the Gulf of Oman and the Arabian Sea.
Geographically, The Musandam Peninsula, an exclave of Oman, juts into the Strait of Hormuz. It has an estimated population of less than 30,000 people, of which around 18,000 live in the capital, Khasab. Its location gives Oman partial control, shared with Iran, of the strategic Strait. Khasab is located 310 miles from Oman’s Capital Muscat, and is dubbed the “Norway of Arabia” due to the long fjords that make up the rocky coast. The Portuguese built Khasab at the beginning of the 17th century at the considered height of their naval presence in the region.
Along the coast of Musandam, various small villages (some no bigger than 10 houses) live mainly from the sea; the Omani Government has made a lot of investments to bring in electricity, fresh water and transportation (with a high speed ferry from Muscat).
The Strait of Hormuz is probably the world’s most important oil chokepoint due to its daily oil flow of almost 17 million barrels per day (bbl/d) in 2011, up from between 15.5-16.0 million bbl/d in 2009- 2010. Flows through the Strait in 2011 were roughly 35% of all seaborne traded oil, or almost 20% of oil traded worldwide.2 At its narrowest, the Strait is 39 kilometers wide (approximately 24 miles).
The village of Maqlab at the bottom of the rock cliffs of the Musandam Peninsula.
Over the last few years, following a major drop in 2008/2009, oil prices have increased substantially, so that the 2012 average so far of US$102.75 per barrel (as of March 25, 2012) is higher than the average of 2008 (US$99.75 per barrel) (see graphs below).
According to experts interviewed in the regions3, the present price of Brent oil probably has a US$20 to US$30 per barrel of geopolitical premium included in it. They do not believe that the tensions with Iran will escalate to the point where the Strait would be closed down. Bypassing the Strait of Hormuz could imply an additional cost for transportation. This would of course generate a dramatic pressure to the world economy, akin to what happened in 2008. As per the US Energy Information Administration, “several alternatives are potentially available to move oil from the Persian Gulf region without transiting Hormuz, but they are limited in capacity, in many cases are not currently operating or operable, and generally engender higher transport costs and logistical challenges”. In the US, a persistent 10 per cent rise in crude oil prices tends to reduce the growth rate of real GDP by an average of 0.2pp in the subsequent two years, that is, lowers the level of real GDP by 0.2% and 0.4% after one and two years respectively. As of March 25th, 2012, the price of WTI has already increased more than 8% since the closing of 20114.
According to Brad Bourland, chief economist and managing director of proprietary investment at Riyadh-based Jadwa Investment5: “Above $100 a barrel, you start to get demand destruction”.
For your reference, the following statistics (of World Energy, June 2011 – www.bp.com/statisticalreview) of global supply and demand are included hereafter6. They reflect the tightness in supply/demand of the oil market, overall.
1This article focuses on crude oil without reference to natural gas or other energy related commodities
2US Energy Information Administration www.eia.gov
3Schrodes Investment and Franklin Templeton Investments
4Goldman Sachs Global Economics, Commodities and Strategy Research: Global Economics Weekly February 29, 1012
5Global Finance; www.gfmag.com/archives
6Extracts from BP Statistical Review of World Energy, June 2011–www.bp.com/statisticalreview
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