QUINCANNON ASSOCIATES INC.
Early in the Middle East conflict, it became abundantly clear how quickly a regional conflict can manifest into a global crisis. With war in the Middle East now well into its sixth month, energy and financial markets continue to experience significant volatility, and the initial surge in global shipping rates has eased as markets find balance and the "new normal" is defined.
A REGION IN PARADOX
The Middle East has always benefited from cheap feedstocks and proximity to the main shipping lanes, so the effective closure of Hormuz is necessitating aggressive capital expenditure on workarounds. Saudi Arabia is diverting nearly 7 million barrels of crude per day through the Petroline Pipeline, while the UAE is implementing aggressive plans to double their own pipeline capacity to 3.6 million barrels per day by 2027 including advanced plans to build out further to include refined products. Iraq has its own projects with the backing of major oil companies and Kuwait is working closely with the Saudis and UAE on their own workarounds.
The closure of Hormuz is no longer a possibility but a reality, and the region seems committed to never permitting Tehran this degree of leverage in the future. The region is adapting, old alliances are being broken, new alliances are being forged, and the countries most impacted by the seizure of the Straits are investing in work arounds which will make this critical waterway less important in the future.
Mainstream media outlets continue to focus primarily on the impact of crude oil and liquified natural gas markets, but to date, very little commentary is being given on the impact the prolonged war is having on petrochemicals, critical building blocks that impact everyday life. Over decades the GCC has invested billions of dollars in basic chemical production as part of a broader economic diversification strategy, but these products are typically produced and sold under much tighter margins.
With these value streams effectively cut off from broader markets, the work arounds are not simple. Producers who don't have the same access to pipelines face significant capital costs to keep refining assets running and maintain connectivity with their end users. Often, these relationships are built over decades, so maintaining connectivity with the customers necessitates aggressive actions. In some cases, this involves truck convoys and leasing storage tanks outside the impacted areas. With these added costs and longer supply lines, margins become stretched and delivered costs significantly higher.
GLOBAL SHIPPING TAKES CENTER STAGE
Traditionally, roughly 80% of Middle East trade relied on maritime transport, so the conflict has put commercial shipping at the center of the mainstream media feeds. The initial wave of vessels stuck inside the region were (for the most part) able to use the brief MOU and ceasefire to get assets safely out of the region, but very few operators had the appetite to send hardware into the region during that very fragile period. The ceasefire was short-lived and Iran quickly renewed their attacks on merchant shipping, again cutting off the region from the broader markets.
For most ship operators, any risk is too great, so vessels are being deployed elsewhere until the region is once again deemed safe. This has resulted in a significant number of vessels being pushed into other markets and perhaps nowhere has that been more evident than the Atlantic Basin. U.S exports continue to benefit from the disruptions in the Middle East, but freight rates have eased due to the surplus of vessels. Although rates remain above pre-conflict levels, bunker prices are 40% higher due to the spike in energy prices, which has a significant impact on daily operating costs and earnings.
Source: Quincannon Associates Market Intelligence, spot chemical rate assessments
“The closure of Hormuz is no longer a possibility but a reality — the region seems committed to never permitting Tehran this degree of leverage in the future.”
Overall, the freight markets have held up well considering the amount of volume which has been removed from the global economy. Prolonged under investment in tankers has created structural shortages and resulted in some very positive years for shipping companies, but the narrative is quickly changing as the orderbook grows and more ships enter the market each day. The inevitability that these ships will be competing with the larger fleet for potentially less volumes will ultimately have far reaching implications on freight markets in the future.
WHAT'S NEXT?
From the outside looking in, it appears the central government in Iran is collapsing with the much more hardline IRGC backfilling the void. Intent on drawing the Gulf neighbors into a prolonged war, civilian and energy related targets continue to come under attack. While the number of attacks on merchant vessels in Straits of Hormuz has declined significantly, the theater has been expanded to Bab Al Mendab where Iran's proxies have imposed an embargo on Saudi shipping looking to pass through yet another key choke point.
With the negotiations clearly at a standstill, and the US Naval blockade suffocating Iran's already fragile economic state, experts are trying to predict when this vital waterway will again be open to free and safe passage. Focus within the region seems to be hinging on the upcoming U.S. mid-term elections, and whether there will be enough of a change in the political wind to force the hand of the Trump administration, or will there be another two years of Trump policy in the region.
For the shipping markets it is again about the ability to adapt and adjust on the fly. With attacks being made outside of the Straits, operators are increasingly reluctant to even call ports in Oman and the Red Sea for fear of drone attacks. For those operators compelled to take the additional risk, there are market premiums, however it is increasingly difficult to find insurance to underwrite vessels operating in these high-risk areas.
There is little to suggest that a return to normal, unrestricted commercial traffic through the Straits of Hormuz is forthcoming. As diplomatic efforts stall, a clear framework for future vessel routing is yet to take shape, leaving significant political and security hurdles firmly in place. Even if an agreement is reached, restoring shipowner and insurer confidence will take time. The longer the disruption persists, the more fixed alternative trade routes and supply chains will become, potentially reshaping Middle East trade flows well beyond the end of the current conflict.
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By Patrick Quincannon
President and CEO
Quincannon Associates