Hormuz Workarounds Keep Gulf Oil Flowing—at a Steep Cost

Ship-to-ship transfers and pipelines bypassing the Strait of Hormuz, where available, have become the primary export route for most Middle Eastern oil. Oil producers in the region have demonstrated what some see as remarkable adaptability to the new circumstances. In fact, it is a matter of survival. And it comes at a cost.This week saw a sharp drop in oil prices on the news that Saudi Arabia had restarted its East-West pipeline. The pipeline was damaged by Houthi strikes last week, and some expected repairs to last months. The effect of the news on oil prices highlights just how crucial for trader sentiment the state of energy infrastructure in the Middle East has become—especially if that infrastructure has nothing to do with the Strait of Hormuz.The East-West pipeline before carried crude to the strait, where it was loaded on tankers and sent on its way to buyers. After Iran shut down the chokepoint, the Saudis reversed flows, which helped keep a lid on prices, even though exports from the Red Sea port of Yanbu were lower in volume due to the lack of adequate port capacity. But then the Houthis began pounding Saudi infrastructure, including the East-West pipeline. The East-West pipeline had been rerouting about 4 million barrels daily across Saudi Arabia to Yanbu before the drone attacks from Yemen forced its shutdown earlier this month. Without it, Aramco was forced to send more crude back to the Persian Gulf, selling tens of millions of barrels for movement through Hormuz and ship-to-ship transfers near Oman.That was how Saudi Arabia joined a growing club of ship-to-ship transfer fans in the Middle East. Previously employed by sanctioned nations such as Venezuela, Iran, and occasionally Russia, now the practice of moving oil from smaller to large tankers became regular in the Persian Gulf. The ship-to-ship transfers take place in the Gulf of Oman, which is outside Hormuz, by means to loading the crude first on small vessels that then travel short distances to transfer the cargo onto larger tankers before returning to reload.This is a viable workaround but, of course, it comes at a cost, adding to the end price of the cargo. This, in turn, has prompted oil exporters from the Gulf to discount their crude, especially notable in the case of Iraq, which does not really have any other option besides Hormuz due to its geography.According to recent Kpler data, oil flows via the Strait of Hormuz have averaged some 6.5 million barrels daily since the start of the month, Reuters’ Ron Bousso reported earlier this week. This compares to roughly 20 million barrels flowing out of the Persian Gulf before the U.S. and Israel began bombing Iran at the end of February. The difference is quite significant but it appears traders have learned to live with the new export rates, so any news of an increase in either production or exports pushes oil prices lower—even though the market remains in deficit.As evidence of how important perception is, the news of the restart of the East-West pipeline trumped information that Aramco has not loaded any crude from Yanbu port since September 16, according to data cited by Reuters, or that those STS exports from the Persian Gulf come at much higher freight costs. Indeed, freight costs have swelled to as much as 25% of the total cost of moving oil from the Middle East to China—a reference route often used by analysts in cost estimates and calculations. A very large crude carrier on that route now fetches freight costs of $30 per barrel of crude—an all-time high.The reason for these much higher costs is shipping risk. Few tanker owners are willing to take that risk, so they are asking much higher prices for their vessels—and a shortage has emerged in supertankers. According to Reuters’ Bousso, this motivated the UAE to use smaller vessels for ship-to-ship transfers int eh Gulf of Oman, and it is paying off. The UAE appears to be on track to boost its oil exports to a level higher than last year’s, when the Strait of Hormuz was wide open for business. Loadings this month are estimated at 3.6 million barrels daily, compared to 3.4 million barrels daily for last year.It seems, then, that oil producers are adapting to a new reality that will likely remain with them for a while yet. It is a much more problematic reality, but as long as some oil gets out of the Persian Gulf, even at much lower than pre-war rates, the market will remain relatively calm. It appears it will remain calm despite President Trump’s latest threat to “annihilate” Iran unless it agrees to a deal, to which Iran responded in its usual way, saying any violence will receive an in-kind response.By Irina Slav for Oilprice.comMore Top Reads From Oilprice.comU.S. Threatens to Ground Iranian Airlines WorldwideOil Prices Reverse Course as Traders Watch US-Iran DiplomacyNorway's Arctic Oil Pitch Falls Flat in Brussels