Energy Security & Geopolitics: Iran and the Strait of Hormuz

Geopolitics beckons. Defined as “a study of the influence of such factors as geography, economics, and demography on the politics and especially the foreign policy of a state,” geopolitics is highlighted by the developing situation with Iran.

The nuclear weapons brinksmanship involving Iran versus the U.S. and European Union (EU) continues to roil tensions in one of the world’s critical oil supply epicenters. At the center of the saber-rattling is the recent threat of an EU embargo on Iran oil and Iran’s retaliatory threat to close the strategic Strait of Hormuz, which of course, means a self-imposed oil embargo rather than one applied by the West.

It is important to look at how this potential oil supply shock might impact both the global, regional and North American oil markets in the sense of oil-specific trade movements, geopolitics and energy security. As the upcoming trade movement piece will further delineate some of the nuances involved in the global trade flows, this piece emphasizes how a geopolitical flashpoint of this magnitude can exacerbate both regional and global oil market sensitivities.

Defining the Players: Nuke-Seeking Oil Rogue vs. OECD Oil Consumers

The tensions are dangerously high. Mohammad Reza Rahimi, Iran’s first vice president, warned that Iran would not allow “even one drop of oil” to flow through the strait should the West impose oil sanctions on Tehran. Iran also threatened to take military action if the U.S. Navy moves the USS John C. Stennis aircraft carrier group back into the Gulf, but the U.S. is proceeding as planned. The Western sanctions ramp-up has targeted both Iran’s financial and oil assets. Not to mention, the U.S. is sending thousands of troops to Israel for a major missile defense exercise. Essentially, a game of chicken with potentially dire consequences has emerged.

Geography Matters

In 2008, Stratfor Chief Executive, George Friedman, spoke at the IPAA Midyear Meeting in Laguna Niguel about future U.S. foreign policy priorities and potential threats. One of them included the importance of sea lanes and the growing importance of the U.S. Navy to keep them open. After all, shipping accounts for 90 percent of world trade in goods.

Sea lanes are indeed critical in a world that relies on oil for approximately 34 percent of its energy supply with over 44 percent of global crude oil exports originating in the Middle East. The Strait of Hormuz is a key oil transit route with approximately 17 million barrels of oil per day (around 35 percent of all seaborne traded oil and 20 percent of all oil traded worldwide) moving through this strategic point of the Persian Gulf in 2010.

Energy Security Lens

Where does Iran stand in the geopolitical list and what does this mean for worldwide energy security? Defined as “an association between national security and the availability of natural resources for energy consumption,” energy security is inextricably linked to geopolitics.

Iran is the second largest OPEC producer and the world’s third largest oil exporter, accounting for almost four percent of global oil output and almost six percent of total world oil exports, according to the EIA. But it is important to illustrate exactly where this oil goes. Just as Libya’s oil production and export shutdown impacted Europe, Iran’s embargo or any potential conflagration involving the Strait of Hormuz, would inordinately impact Asia and Europe, two regions with growing import dependence on the Middle East.

The EU imports almost a fifth of Iran’s oil. In particular, Italy receives about 13 percent of its crude from Iran, making it the most vulnerable to such a supply shortfall. Iran and Libya are Spain’s second and third biggest suppliers of crude oil. Another 1.3 million barrels go to Asian OECD countries such as Japan and South Korea, while another 1.2 million barrels go to China and India who are the top two recipients of Iran’s oil. According to numbers released by Deutsche Bank, Iran is China’s third largest oil source, accounting for 11 percent of China’s total imports.

If the ban goes into place this month as expected, the oil supply dislocation could add considerable stress to the already hobbled economies of Greece, Italy and Spain. A contingency plan to tap the International Energy Agency’s (IEA) strategic stockpile has already been composed and due to larger strategic and commercial stockpiles, the U.S. has much more cover than in the past.

The pain would be most severe for Iran, which relies on crude revenues for around 80 percent of its foreign exchange earnings. Given their client list, Iran could be hard pressed to make up for the large chunk of their crude market portfolio in the short-term. There are various forecasts regarding the extent to which Iran’s actions would ‘shock’ the oil price, with many analysts hovering around $150/bbl for the short term squeeze.

American Energy Security: Translating Geopolitics to U.S. Oil Markets

This unfolding scenario underscores several main themes for the U.S. and domestic energy markets. On the positive side, the U.S. does not directly import oil from Iran. Second, the U.S. is gradually reducing its dependence on the Middle Eastern region. The percentage of our imports from the Persian Gulf has dropped from 24.5 percent in 1990 to 14.5 percent in 2010. Third, our total import dependence is declining. U.S. net imports have dropped from over 60 percent of our total consumption in 2005 to around 45 percent in 2011 through November. As the upcoming trade piece will demonstrate, almost 52 percent of our oil imports emanate from the Western Hemisphere.

All those who once claimed that the U.S. was destined to increase its dependence on Middle East supply as we ran out of oil and natural gas are busy re-working their obsolete scripts. U.S. energy dependence is indeed falling and our energy security leverage has vastly improved due the U.S. shale oil and natural gas boom. Thanks in large part to America’s independent producers, analysts are positioning the U.S. as the top world oil producer within the next ten years.

The world’s trade-oil interdependence makes America more sensitive to Middle East export exposure. Since almost 15 percent of U.S. imported oil still comes from this region, we are far from immune to regional flare-ups affecting global oil supply. Oil is a globally traded commodity—higher prices in the more Middle East-dependent Asia and Europe will have a ripple effect that will lap American shores. Given the current debilitated state of world markets, every bit of negative economic news from Europe or China exacts a toll on our recovering economic markets because they are two of our top trading partners. Any oil shock of this magnitude would pass quickly through the global business cycle as energy costs directly impact trade flows, industrial activity and consumer spending which comprises over two-thirds of the U.S. economy.

America’s revitalized energy footprint gives our country increased options regarding our energy trade, national security and foreign policy. Clearly, the Iran case study reveals that energy remains one of the most critical multilateral assets in the world.  Domestically, U.S. policymakers must do everything they can to increase this energy security that is so tied to geopolitics. Increasing access to our nation’s vast reserves both offshore and on federal lands is a good start. Also, approving the Keystone XL pipeline would ensure more of our imported oil came from a friendly trading partner rather than a hostile, unstable region. As we begin the second decade of the 21st century, geopolitics and energy security influence U.S. policy more than ever.

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