Most of the focus on the implications of the closure of the Strait of Hormuz has been on the price of crude oil. The impacts that matter most, however, are on products that are not so crude.
While the headline numbers say that most of the nearly 20 million barrels a day, or 20 per cent of the world’s production, that used to flow through the Strait has been stoppered by Iran’s response to the US-Israel attacks, included within that number is about 3.3 million barrels a day of refined products, or about 13 per cent of the global market.
End-users of the products derived from crude oil don’t consume the crude itself, but the products produced from the refineries that process it. Those include petrol and diesel, jet fuels, the raw inputs for plastics, fertilisers, explosives, solvents and even cosmetics and soap.
The conflict’s spread from Iran into the surrounding region has not only impacted crude supply and production. As producers have run out of storage capacity, they have already reduced production by about 7.3 million barrels a day, according to Goldman Sachs analysts.
It has also caused outages at Middle Eastern refineries that have taken about 2.2 million barrels a day out of production. The International Energy Agency says more than 4 million barrels a day of refining capacity is at risk.
That means there are two layers to the flow-on effects from the Strait’s closure. One is the flow of oil to be processed at refineries outside the region, the other is a direct hit to production of refined products from the Middle East – a global production hub – itself.
The impact of the interruption to supply is generally measured by fluctuations in oil prices, which have soared from around $US70 ($98.50) a barrel before the attack on Iran to around $US103 a barrel this week.
The impact on downstream products, however, is more marked and has far more economic consequences.
Petrol prices, of course, are front of mind for consumers. In the US, they’ve leapt from $US2.92 a gallon to $US3.79 and, in Australia, have recently averaged (nationally) about $2.30 a litre. Before the conflict, they were averaging just over $1.70 a litre.
Diesel, which feeds into transport costs and ultimately into consumer prices, has traded above $US5 a gallon in the US this week for the first time since the onset of the war in Ukraine. It was $US3.65 a gallon before the Americans and Israelis began the war. In Australia, diesel prices have jumped from around $1.80 a litre to around $2.60 a litre.
One of the least processed outputs from refineries is fuel oil, used as fuel for ships, power plants and, in some regions, heating.
Its price usually reflects a small discount to crude prices because its production involves less processing, but it is now trading at premiums of 40 to 60 per cent above crude prices. The cost of seaborne transport of goods is rising materially.
The significance of the reduced supply of refined products from the Middle East and the disruption of crude oil supply to refineries outside the conflict zone isn’t, as our farmers and those queuing up for petrol and diesel have recognised, only on prices.
It also impacts availability, which will be of increasing significance to prices and economies if the conflict is prolonged.
Refineries are set up to process particular grades of oil with particular levels of sulphur. The Middle East supplies about 30 per cent of the world’s oil, mainly light to medium crudes with high sulphur contents.
Already, the prices of some of that oil, particularly from countries whose production isn’t affected by the closure of the Strait and is therefore still available, have soared well above – as much as $US50 a barrel above – the benchmark price for Brent crude, driven by a combination of the overall reduction of supply and particular refineries’ needs for oil with particular characteristics.
Much of the crude the Persian Gulf producers export – nearly 13 million barrels a day – goes to Asian refineries (which is where most of Australia’s petrol and diesel comes from), supplying about half their requirements.
There it is processed into petrol, diesel, naphtha, jet fuel, fuel oil, lubricants and other products and by-products, like sulphur and urea, that are key ingredients in fertilisers, explosives, solvents, plastics, the production of paper and detergents. About two-thirds of the urea Australia uses for fertiliser production comes from the Persian Gulf.
Global oil benchmarks provide barometers of the market conditions but, until the war ends and the fog of war lifts, the extent and permanence of the damage to the world’s oil-dependent industries and their customer bases can’t be calculated.
China has already begun limiting its exports of urea to protect its domestic supply. Japan and South Korea, which each import more than 60 per cent of their naphtha supplies, mainly from the Gulf, are already closing petrochemical plants, with other producers reducing their outputs and declaring force majeure because of their inability to meet their contracts with customers.
In the US, the Trump administration is racing to find alternative sources of fertilisers to replace the Middle Eastern products, and there are concerns that an extended conflict could have severe implications for global food supply.
Hit hardest by the reduced supply and spiking fuel, transport and fertiliser prices will be the Asian economies, because 90 per cent of their oil and refined products come via the Strait and they have few, if any, energy resources of their own. Europe, also dependent on imported energy, will also face a significant increase in energy costs.
Sub-Saharan Africa, South-East Asia, India, some Latin American economies and Australia will be hurt by the reduced and disrupted supply and the higher prices of fertilisers.
The Middle Eastern economies, obviously, are losing enormous amounts of oil revenue – more than $US500 million a day, if not more – from their lost sales and reducing production, although they should be able to recover much of that if and when the Strait re-opens.
The degree to which oil-derived products are embedded deeply within economies means that the war will disrupt global supply chains and costs, with some of the effects persisting beyond the end of the conflict and a return to normal operations in the Strait, whenever that might be.
Global oil benchmarks provide barometers of the market conditions, but until the war ends and the fog of war lifts, the extent and permanence of the damage to the world’s oil-dependent industries and their customer bases can’t be calculated.
It is already apparent, however, that there will be a global price to pay, and a substantial one, for Donald Trump and Benjamin Netanyahu’s decision to initiate a war within the centre of the world’s most important region for the production of oil and its derivatives.
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Stephen Bartholomeusz is one of Australia’s most respected business journalists. He was most recently co-founder and associate editor of the Business Spectator website and an associate editor and senior columnist at The Australian.Connect via email.
