Iran-Israel Conflict: The Strait Of Hormuz Remains A Key Focus

Oil markets witnessed an unusual calm on Monday, even after Iranian drone and missile attacks on Israel over the weekend. However, with warnings from top Israeli military officials signalling a strong response is imminent, the potential for major disruptions to the world's oil supply looms large.

At the crux of this significant risk is a narrow sea passage—The Strait of Hormuz—which helps transport 15% of the global crude consumption.

While Israel and Iran have been in a decades-long proxy war, tensions in an already tight oil market surged after Iran launched an attack that involved 300 drones and missiles against Israel on April 13. The drone strike was in retaliation to an alleged Israeli airstrike on Iran's embassy compound in Syria, which killed a top Iranian general and others on April 1, as reported by Bloomberg and other media organisations.

The ball now lies in Israel's court. According to Bloomberg, high-ranking Israeli military officials have reasserted that Israel has no choice but to respond to Iran’s weekend attack. This comes despite the European and US officials calling for Israel to avoid a tit-for-tat escalation. US President Joe Biden himself made it clear that the US will not back Israel in any offensive operations against Iran.

Iran is a founding member of the Organization of the Petroleum Exporting Countries and according to the International Energy Agency, the country produces 3.2 million barrels of oil per day. In 2023, the country was the world's second-largest source of supply growth after the US, according to the agency.

It currently exports 1.5 million barrels of crude per day, with China being its biggest customer. The IEA estimates Iran's oil production to rise by 2,80,000 barrels per day in 2024.

Now, while Iranian oil is currently under sanctions, further escalation of the Israel-Iran conflict could hamper the supply growth globally, and further increase Brent prices which are already up 19.5% year-to-date.

A possible aggressive response by Israel could convert the conflict into a wider war, threatening the closure of the Strait of Hormuz, which is a 40-km narrow sea passage between Oman and Iran, and is a key point for global crude supply.

The strait is a significant route through which crude oil is exported by Saudi Arabia, the UAE, Kuwait, Qatar, Iraq as well as Iran. According to Motilal Oswal, about 15 million barrels of crude oil per day flows through the state, representing 15% of global crude consumption. According to the IEA, around 80% of crude oil is exported via the Strait of Hormuz to Asia, with China, India and Japan being the top destinations.

Furthermore, Qatar, the world's biggest liquefied natural gas exporter, sends almost all of its LNG through the Strait.

Around 80% of LNG transported via the strait is intended for Asian markets, and an estimated 25% of all of Asia’s LNG imports in 2023 were delivered via this key route.

Saudi Arabia and the UAE both have alternative export routes, which avoid the Strait of Hormuz. However, the pipelines on those routes open up into the Red Sea, where traffic flow has already been disrupted due to attacks by the Houthi rebels.

Additionally, the alternate routes would be able to accommodate only 7–8 million barrels of oil per day, which is a fraction of the volume currently passing through the Strait.

According to Motilal Oswal, if Iran successfully enforces a blockade of the Strait, the event will not only lead to higher crude oil prices but also to an increase in gross refining margin and spot LNG prices, which are currently trading at lower than historical values.