Vulnerability of global oil market in light of the looming Persian Gulf crisis

Over the past several weeks the petroleum market has experienced the most significant daily price spike since 1990-91 Gulf War - the result of a sophisticated drone attack on Abqaiq and Khurais oil facilities of Saudi Arabia. On the next trading day following the incident, the spot oil price of Light Crude surged more than 15% - from 55 up to 63 USD per barrel. It took two weeks for the price to gradually return to its pre-attack levels. Though the attack paralyzed nearly one half of Saudi oil capacity, the effect was short and within days production returned to normal. However, the real question is whether this attack is a standalone incident with no long-term effect or another major step in the escalating conflict between Iran and Saudi Arabia, which could repeat the Persian Gulf oil crisis of the 1980s.

Now, three weeks after the incident, as oil prices are once again relaxed, we can obtain some short term conclusions. The oil spike has indeed generated some revenues and losses to certain players, but this was largely translated into short-term option trading and this is not the topic of this review. Nor Iran nor Saudi Arabia has experienced significant changes in direct oil revenues as a result of the incident. When we consider the historical precedents, the first, second and third Gulf wars are a fair comparison in case the situation is to continue deteriorating.

In 1979, the oil price surged from 15 to more than 32 USD per barrel that year as as high as 39 USD per barrel, as Iran was thrown into chaos by the Islamic Revolution. During the Iran-Iraq War, which erupted in September 1980, the oil price had in fact stabilized at around 30-35 USD through most of the war and it was only in 1986, the oil price could finally drop to as low as 10-12 USD per barrel. In November 1986, the Kuwaiti petition could finally draw international protection to shipping and terminate the Tanker War. Oil price had remained at 15-20 USD per barrel levels through the final stages of that conflict.

Another Persian Gulf conflict emerged in August 1990, as Ba'athist Iraq stripped of cash in the aftermath of the Iran-Iraq War decided to initiate its Kuwaiti adventure and draw the NATO into perhaps the most notorious oil-motivated conflict of modern era - the 1990-91 Gulf War. Upon the invasion to Kuwait, the oil price surged by 100% - jumping from 21 to nearly 40 USD per barrel. This was however a much shorter effect on the global market - by March 1991 with the finalization of operation Desert Storm, the price was back below 20 USD per barrel and remained there through most 1990s.

Interestingly, the 2003 Invasion of Iraq had an even less dramatic effect on pricing - the oil price indeed surged from 20-30 USD levels (during 2000-2002) to as high as 37 USD in February 2003, but was already back at 27 USD per barrel level in April. The pricing spike of the 2003 invasion was indeed minor, though a more long-term effect can be attributed to the resulting Iraqi instability as Iraq War in fact lasted for eight long years. The Iraq War is certainly carrying a partial responsibility for the oil price increase leading to 2008 oil crisis, but is certainly not the sole reason behind it.

So, where is the oil market heading now? The line of incidents in the Persian Gulf since May 2019 is already including multiple tanker sabotages and abductions, while Saudi oil facilities are suffering from a sequence of security incidents of which the Abqaiq-Khurais was the most notable. The obvious standoff between the Saudi-led Arab countries supported by US against Iran and its proxies is escalating and with further incidents may begin to resemble the Tanker War of the 1980s, bringing not just psychological effects, but also an actual mid-term and long-term impact on global oil supply. Despite a significant change in the global energy market towards natural gas and renewables, the oil is still responsible for 34% of primary energy supply (mostly for transport). With more than 20% of global oil coming through the straits of Hormuz and an even more significant percentage if including Omani oil terminals, the stakes are high and the potential effect of another Persian Gulf flareup on global economy is significant. Considering the worst case scenario of Tanker War II with knockout of multiple oil supply sources in the Persian Gulf, oil price might double from its current 50-60 USD per barrel level for a significant period of time.

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