For fifty years Pentagon planners, whose job it is to analyze risk and threats around the globe, have concluded year after year that the closure of the Strait of Hormuz is the worst possible scenario to confront - but it never happened – until now! The world is now witnessing firsthand what scared the military analysts. When big flows of oil and gas are interrupted it doesn’t take long to disrupt economic activity. Disrupt it long enough and the world economy grinds to a crawl. The fog of war is still thick. The fog of resolution is thicker still. How does this situation end? Understanding the Strait of Hormuz is an important first step.
The Strait of Hormuz has been a link in world trade routes for 4000 years but only in the past century has it become the strategic juggernaut it is today. The Strait is an international body of water 24 miles wide that separates the Persian Gulf and the open ocean. The Persian Gulf is a 615 miles long body of water bounded on the northeast side by Iran and on the southwest side by Iraq, Kuwait, Saudi Arabia, Qatar and the United Arab Emirates.
What makes the Persian Gulf and its surrounding states unique is the geology - the planet’s most prolific oil and gas fields. This is the home field for the Organization for Petroleum Exporting Countries (OPEC). And export they do - in normal times 20 million barrels of oil pass through the Strait daily. In total 20% of the world’s oil, LNG and fertilizer are exported out of the Persian Gulf. Shut that 20% down and chaos ensues.
The global logistic network developed over the past century to discover, extract, refine and deliver oil, gas and their myriad byproducts to the far reaches of the world and have them there reliably at reasonable prices is one of the great marvels of the free market. It is one of the world’s most complicated and vital supply chains. Shut down 20% of the flow of the world’s oil, gas and fertilizer for almost a month and you scramble the finely orchestrated logistics that provides critical inputs to the transportation, industrial and agricultural sectors of the world economy. Prices turn volatile and shortages disrupt production.
Meanwhile the financial markets have a role to play via futures markets where prices trade based on needs and production at future dates, one, two or more years ahead. The futures market may price a barrel of oil two years from now at $74 but that means nothing to the traveler flying to Singapore or Paris when Jet Fuel prices are $180 versus $100 a month ago. That current $180 Jet Fuel price is a warning of the hazard we face should the Strait remain closed longer than expected.
Today’s crisis is the mirror image of the covid crisis in 2020. Covid driven decisions to shutter vast swaths of the economy created a lack of ‘demand’ shock to energy and many other sectors of the economy. This is a lack of ‘supply’ shock that could take months or years to stabilize and meet pent up needs.
Extraordinary damage has been done to infrastructure that will impact oil and gas supplies and supply lines for months and years to come. Most notable is the damage to LNG facilities at Qatar. Qatar was the largest exporter of LNG and much of their production is now shut down. This is already redrawing the world’s energy maps. The price of LNG in Europe has jumped 60% in the last month. Qatar was their primary provider of LNG and they need it for electricity. LNG exporters in the Gulf of America are working to help meet those needs. Consider that in context with last year’s events in Venezuela and a teetering Cuba.
How does this end? No one knows. Kinetic conflicts are dangerous events and always have unintended consequences. The damage done is massive and some of it will take years to repair. One thing for sure, when the fog of war clears the world’s energy map will look different than it did a year ago.
Ashby Foote III is President of Vector Money Management and serves on the Jackson City Council, Ward 1. He is on the board of Bigger Pie.
