Verleger's View on Iran's Strait of Hormuz Threats

Efforts to squeeze Iranian oil out of market will put upward pressure on prices

Carole Donoghue, Petroleum Editor

WASHINGTON -- Action during the next two or three months would be the "least harmful" for the United States if it plans to take on Iran over the regime's threats to close the Strait of Hormuz, said veteran petroleum industry economist and analyst Phil Verleger.

February to May is usually the lowest period for global oil demand, he noted. Consumption is expected to average about 90 million barrels per day (bpd) in 2012. If the usual seasonal trends prevail, demand will likely drop to 88 million bpd or so in April and May, before rising again in the fall.

"If one must go to war--and we pray we do not--the conflict would be best fought in February or March," said Verleger, a former senior adviser on energy to the Carter Administration and formerly the David Mitchell/EnCana professor at the Haskayne School of Management at the University of Calgary.

Iran's current "chest-beating" is regarded as largely hollow, but that does not preclude the United States and Europe from goading Iran into hostilities by aggressively and rapidly tightening economic sanctions against the regime, Verleger said. Aggressive efforts by the United States and European Union to squeeze Iranian oil out of the market will put upward pressure on crude prices as Iran's customers search for other supply sources.

Some Western countries are already laying the groundwork for a release of oil from strategic reserves should Iran try to carry out its threat, according to diplomats and industry sources cited by Reuters.

Senior executives of the International Energy Agency (IEA), which advises 28 oil consuming countries, on Friday discussed an existing plan to release 14 million bpd of government-owned oil stored in the United States, Europe and Japan, as well as other countries, the news service said.

A release of 14 million bpd of oil would be five times the agency's biggest release in the past, made in response to Iraq's 1990 invasion of Kuwait. Opening the spigot for 10 million bpd of crude and about 4 million bpd of products could be sustained during the first month of any coordinated action, according to the IEA plan.

"The navies and air forces of the United States and other nations should be able to end any blockade within 30 days," Verleger noted.

After the Reuters report, the IEA issued a statement saying that it "constantly monitors developments in global oil markets," and that the situation in the Middle East "is no exception." The IEA is prepared to respond to any significant supply disruption, but is not "actively considering" any action at the present time, it said.

"In other words," said Verleger, "the documents have been prepared but await the appropriate signatures."

The upcoming U.S presidential election also provides an incentive to fight the battle now, he added. Neither Republicans nor Democrats would want Americans going to the polls while markets are distorted. Democrats would not want to risk the price spike and Republicans would not want to be in a position of defending an industry that is trusted, according to a December 11 Harris Poll, by only 6% of Americans.

Iran tried to close off the seaway 23 years ago but never quite pulled it off. Lloyds of London estimated that that effort led to damage to 546 commercial vessels and the deaths of 430 civilian seamen, but most of those losses were caused by Iraq, not Iran, said Verleger, citing a Council of Foreign Relations expert.

Some 17 million bpd passed through the Strait in 2011, which was an increase of more than one million bpd seen in 2009 and 2010, according to the U.S. Energy Information Agency (EIA). But the end of the Iraq war, and a decline in European economies, will likely lessen the impact on global markets of any action to close the Strait on global markets, with only an estimated 13 million bpd passing through in February and March.

The National Defense Authorization Act signed by President Obama on the last day of December gives him the power to impose additional sanctions on any country's whose central bank does business with Iran. The aim is to reduce purchases of Iranian crude. Some nations--Korea, for one–are already moving to switch to other oil supply and Saudi Arabia is obligingly offering Asian buyers discounts of as much as $2 per barrel.

Verleger said he believes that the threat to close the Strait of Hormuz is a reaction to sanctions-tightening by the United States as well as Europe, the offer of the Saudis and other Gulf countries to boost production and lower prices.

"One should expect more excitement and more provocations in the coming weeks," Verleger said.