Oil Tanker Traffic in the Straits of Hormuz

Oil tanker traffic is down to near zero from on average 60 ships per day before hostilities

At the start of this week, the oil market was incredibly complacent about what was happening. I wrote a post noting that 20 million barrels of oil transit the Straits of Hormuz every day, which is almost three times as much oil as Russia exports. There’s no doubt that what’s happening now is an order of magnitude bigger - in terms of potential fallout for oil markets - than Russia’s invasion of Ukraine.

The reason I was more bearish than most is because the Iranian regime is battling for its survival. Since it has no hope of matching the US and Israel militarily, its only play is to spike oil prices as much as possible, in the hope that popular sentiment in the US turns against this war. The most obvious way to do that is to blow up an oil tanker in the Straits of Hormuz or - failing that - attack infrastructure around ports, pipelines and oil wells. The US has announced it’ll provide insurance and navy ships to escort tankers through the Straits, but that doesn’t really eliminate the problem. Iran can still severely disrupt global supply by targeting oil infrastructure.

Since the start of the week, markets have moved to price more of a risk premium. The Brent oil price is now up 18 percent since the end of last week, as the blue line in the chart above shows. The black line shows the path of Brent after the Ukraine invasion. Given how much more important the current episode is for oil markets than Russia’s invasion of Ukraine, there’s still upside risk to oil prices, but - at least - we’re now pricing a more meaningful risk premium.

The chart above shows the weekly number of oil tankers transiting the Straits of Hormuz in both directions. The blue line shows tankers going from West to East, which means these are fully laden tankers heading out of the Persian Gulf. The black line is empty oil tankers heading into the Persian Gulf to load up, i.e. they’re going East to West. In both cases, tanker traffic has ground to a halt and the question now is whether US assurances of protection can unclog this. I’m doubtful.

To see why I’m skeptical, look at the chart above. It’s the same data as in the previous chart, but it now shows the same data on a daily basis from Feb. 8 through Mar. 4. On any given day before hostilities began, there were 60 oil tankers going back and forth through the Straits of Hormuz. Trying to protect so many ships is a massive logistical undertaking. All Iran needs to do is to sneak through a couple of drones to blow up one ship and we’re going from what is currently a very serious incident to a massive oil shock. In short, I don’t think US assurances of navy escorts are all that credible. There’s just way too many oil tankers that need protecting.

We’ve come a long way on oil prices since Monday and are now pricing a decent risk premium. But the comparison with oil prices after Russia’s invasion of Ukraine and the reality on the ground - the sheer number of oil tankers that need protection - suggest risk to oil prices is still to the upside.

I should add that any actual attack on an oil tanker would have catastrophic consequences for markets. Oil prices would spike, the Dollar would rise sharply, emerging market central banks would be selling Treasuries to mobilize Dollars so they can stabilize their currencies. All this could spill back to the US Treasury market by destabilizing the basis and swap spread trades. The US and global markets are very vulnerable.