Iran-Israel tensions could stymie Persian Gulf oil shipping, trade lanes

The flurry of drone and missile attacks by Iran on Israel over the weekend, if escalated, could significantly influence trade flows via the Strait of Hormuz, the world's most critical shipping lanes, leading to severe consequences for the global tanker freight and maritime insurance markets, market participants at Singapore Maritime Week and across the globe said April 15.

For the last few months, the additional war risk premium in the Red Sea has been 0.5%-1.0% of the value of the hull and machinery of the ship varying with age and size, compared with 0.0001% in the Persian Gulf, sources said, adding that it's the latter's turn now to rise significantly. Tankers' freight has already been elevated since last year due to the ongoing wars in Gaza and Ukraine, along with the unrest in Yemen and Sudan, sharply slowing down the transit through the Red Sea.

According to the S&P Global Commodity Insights data, Long Range II, or LR2s, moving gasoil and jet fuel on the Persian Gulf-UKC route now cost $4.7 million per voyage, up 20% from the eve of the Hamas' attack on Israel in early October.

"It all depends on how Israel retaliates or does not. Any escalation of conflict can impact the flow of oil and affect freight and crew wages," said a VLCC broker whose cargoes are currently moving on the Persian Gulf-East Asia routes. The perception of increased supply-risk disruptions, following Iran's attack may accelerate shipments and tighten the supply of tankers, which, in turn, is "freight" friendly for owners, said Oslo-based Ole-Rikard Hammer, senior analyst for oil and tanker markets at Arctic Securities.

The Strait of Hormuz is a very narrow shipping lane, the broker said, adding that even if three frigates are parked there or two tankers are blown up and grounded, the entire flow of oil from the region will come to a halt.

Although Israeli retaliation on Iranian soil is unlikely at this stage, any escalation could paralyze commercial shipping in the region, said Noah Trowbridge, a Paris-based maritime risk analyst at Dryad Global.

In spot chartering deals, anywhere between 140 and 160 VLCCs load up to 2 million barrels each in the Persian Gulf every month, according to the brokers' estimates. However, when considering time-chartered ships and also tankers of other sizes, the actual volume is much higher.

The Persian Gulf and the Red Sea regions have close to 40% share in global oil exports with more than 20 million barrels, equivalent to 10 VLCCs of oil and refined products and over 10 Bcf of LNG daily moving through the Strait of Hormuz alone, according to the shipping industry estimates.

"The situation is very fluid and any panic buying of crude and refined products can push up not only the cost of cargoes but also the freight," said a Tokyo-based chartering executive with a global commodity trading company.

Conversely, if oil importers dig into existing reserves rather than purchasing parcels during an escalated conflict, then the gains in freight will be capped, the same VLCC broker added. The fact that freight remains strong despite the market having entered the lean season is a clear indication that underlying fundamentals are tight, said Hammer.

Alternative sources

Heightened tensions imply that importers would look for alternative sources to meet their burgeoning energy needs.

Crude from the US and West Africa will become more attractive from the point of view of sourcing, but its delivery will be more expensive, the broker said.

Already, the US, the world's largest crude producer, has emerged as a major supplier to Europe in the aftermath of the Russia-Ukraine war. In the last 12 months, an average of eight VLCCs, 10 Suezmaxes and 13 Aframaxes are moving crude each month on the US-Northwest Europe route, according to S&P Global data.

"Any additional export demand pressure on the US will push up cargo prices and freight," a chartering executive in Seoul said. Energy supplies are ample but geopolitical disruptions are becoming a logistical nightmare, the executive said. Brokers estimate VLCC freight on the US Gulf-North Asia route at over $32/mt, up almost 4% from the beginning of the year.

This does not include the additional war risk insurance costs, which are already high.

Security concerns and crew wages

The issue here is not restricted to just the cost of war risk insurance, as some of the tankers are just not willing to pass through the conflict zones, said a maritime insurance executive in Singapore.

If the Protection and Indemnity, or P&I, clubs do not provide adequate insurance cover to pass through such areas, trade will slow down or charterers will opt for longer but safer routes.

"We are discouraging our members to use the Red Sea to move cargoes from Persian Gulf to Europe," said an executive with an international P&I Club. On a year-on-year basis, traffic through the Suez Canal fell 40% and 55% in March for dirty and clean tankers, respectively, thereby adding to the ton-mile demand due to the longer voyages via the Cape of Good Hope, said Enrico Paglia, a Genoa-based research manager with shipping brokerage and consultancy Banchero Costa.

During the Iran-Iraq war of the 1980s, only 20% of the global tanker fleet was lifting cargoes from the region in blackout conditions and wages of seafarers had doubled, said a navigator who sailed in those tankers.

The risk profile of tanker vessels operating in the region is unchanged, as ships operating in the Persian Gulf, Gulf of Oman and Arabian Sea are already at a heightened risk of being targeted, said Trowbridge.