Red Sea turmoil has so far spared oil supplies, but buyers have reasons to worry

A series of attacks on shipping routes in the Red Sea has so far spared oil supplies from witnessing major disruptions, but oil importing countries are spending sleepless nights amid concerns that any escalation could potentially alter the situation drastically.

Although the attacks disrupted container shipping lines, oil shipments remain largely stable. However, concerns stem from the fact that supply chains will likely have to adjust very quickly should the disruption persist. As existing oil tanker contracts are often hard to change, some ongoing traffic will continue to move through Red Sea passages.

Any new insurance issued for Red Sea routes could add about $1/b or more to voyage costs, according to S&P Global Commodity Insights. Re-routing will increase voyage length, in-transit times and fuel costs. In addition, it will result in higher vessel utilizations, which could lift global freight rates as well as widen inter-regional crude spreads.

Surely, more ships are avoiding the Red Sea and Bab al-Mandab strait after a spate of attacks by Yemen's Houthi militants, threatening the strategic chokepoint for global seaborne trade. Many shippers, tanker owners and some oil companies have suspended voyages through the area.

Russia's oil exports are particularly exposed to further Red Sea disruptions as Moscow ships some 80% of its crude to Asian markets.

The attacks are expected to keep insurance costs high and prompt many tankers to take the longer route via the Cape of Good Hope, increasing ton miles and voyage durations, as well as tightening supplies and driving up freight rates.

Even for the route via the Suez Canal, higher fees effective this year combined with a carbon tax for Europe-bound cargoes, will increase overall costs for charterers.

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Although the rerouting of tankers away from the Red Sea, a major conduit for oil loaded in Russia, will surely raise shipping costs, the impact will be transitory. Roughly 7 million-8 million b/d of crude oil and products transited the Red Sea in recent months, according to S&P Global data.

The market, for sure, will adjust to the changing flows, but the re-routing will lead to more oil on the water for a longer period of time. Russian crude shipments, should they avoid the Red Sea, are most affected due to a much longer haul to Asia around Africa.

And amid tighter fleet capacity, lingering geopolitical conflicts are expected to boost tanker freight in 2024 despite ongoing OPEC+ supply cuts and a possible slowdown in oil demand growth.

Implications for Asia

As the biggest oil importing region, Asia may not witness dramatic changes to near-term oil supplies amid the ongoing Red Sea crisis, but refiners are chalking out alternative plans to ensure steady feedstock flows in the event of an escalation, a move that could inflate insurance costs and crimp refining margins.

Although the region relies on imported oil for the bulk of its needs, the strategic push among Asia's top importers to massively diversify their import baskets over the years, as well as expand strategic storage, will come in handy to ensure smooth and uninterrupted flow of feedstocks.

The Red Sea crisis has three aspects to it, as far as Asian oil flows are concerned. First, any escalation will create hurdles for Russian crude flowing to Asia, forcing buyers to look for substitutes from other origins.

Secondly, for products moving from Asia to Europe, exporters are cautiously watching developments before taking the plunge. And lastly, longer routes have the potential to create incremental bunker fuel demand in Asia.

Oil flows into China have not been impacted much by the Red Sea turbulence, as fewer cargoes are headed there on that route. In addition, the impact on Russian oil flows to India has been minimal, with no major diversions seen so far. Russia contributed over 35% of India's total crude imports in 2023, amounting to 1.7 million b/d, according to S&P Global data.

Asian oil buyers are not necessarily concerned about Middle Eastern sour crude supplies for 2024, as major sellers, including Saudi Aramco and Abu Dhabi National Oil Co., fully respect Asian customers' demand regardless of their production cut commitments.

However, the economics for cracking Middle Eastern sour crude have been deteriorating as the costs of bringing Persian Gulf barrels to the Far East have been rising with shippers demanding risk premiums, while tanker insurance costs are also trending higher.

Asian refiners may even look at cutting Middle Eastern term contractual volumes and explore other options like African, US and South American crudes to maximize margins. US crudes, for one, is becoming increasingly more attractive for Asian refiners as the price of lighter and sweeter WTI crude is nearly on par with high-sulfur Persian Gulf grades on a delivered basis.

Supply cushion

The attacks in the Red Sea continued even after the US-led alliance took military action to establish deterrence.

The risk of a wider escalation also increased with Pakistan's retaliatory strikes against Iran for alleged Iranian militant attacks in Pakistan. Overall, the geopolitical tensions in the Middle East have only increased over the weeks.

However, oil markets have largely shrugged aside the risk due to a lack of physical disruption to oil shipments and weak macro fundamentals. But increased risk in the Middle East is probably putting a floor to oil prices amid weak demand.

S&P Global expects fundamentals to improve in the second half of 2024 and prices to move up.

Still, OPEC+ market management and the alignment between Saudi Arabia and Russia on OPEC+ policy will be critical for oil markets in 2024.

S&P Global forecasts Platts Dated Brent to average $83/b in 2024 and $76/b in 2025. A sharper economic slowdown or disagreement within OPEC+ on production restrain remains the biggest risk for oil markets going into 2024.

Further reading: Red Sea shipping risk