How the attack on Iran is affecting global oil markets

Over the weekend, the U.S. and Israel led an attack on Iran, which killed the country’s supreme leader, Ayatollah Ali Khamenei.

Since the initial military operation, three ships have been attacked in the Persian Gulf, a refinery in Saudi Arabia was temporarily shut down after it was attacked by drones, and Iran has reportedly closed navigation through the Strait of Hormuz, leaving hundreds of ships sitting idle. Oil prices jumped on Monday in response to the conflict.

Marketplace’s Sabri Ben-Achour was joined by Fernando Valle, managing director of energy for the investment firm Hedgeye Risk Management, to learn more about what this all means for global energy markets. The following is an edited transcript of their conversation.

Sabri Ben-Achour: Oil futures, oil prices are up — supply and demand. What specific developments in this conflict are pushing those prices up right now?

Fernando Valle: I think there are a few aspects here. One, obviously, is the disruption — the immediate disruption that you're seeing. There are fewer tankers coming around the bend on the Strait of Hormuz, which is close to 30% of world oil production. That is a combination of both just pausing because of the attacks and not to have any risk, but then there's also the issues of insurance and several insurance companies canceling insurance for ships transiting in the Strait of Hormuz. And that kind of disruption would force the oil market to consider some form of rerouting. There's just not a lot of ways to reroute that much oil within a very short time frame.

Ben-Achour: How big of an oil producer is Iran, and where does that oil go? And is that oil not flowing now?

Valle: The oil is still flowing. There's been no news of an attack on Kharg Island, which is their main export hub. It accounts for 80% of exports. Iran is a fairly large producer — close to 4 million barrels a day. They export just under 2 million barrels a day, which primarily goes to China. It's over 80% goes to Chinese refiners.

Ben-Achour: Is China still getting that oil? Is it paying more for it? What does that mean for China?

Valle: It's certainly going to pay a lot more for oil and natural gas that goes through the Strait of Hormuz; they are the largest importer of oil globally. The U.S., as you may know, produces 13 and a half million barrels a day roughly. With Canada, we are close to 18 million barrels a day of production versus our 20 million barrels a day of consumption. So we're fairly evenly balanced, whereas China still imports over 13 million barrels — sometimes as much as 15 million barrels a day — of oil. A lot of that comes from the Middle East. Iran can account for over 10% of those volumes. Iran, because of the sanctions, was selling at a much lower price. China is now going to have to find a different supplier, potentially at a significantly higher cost than it was paying Iran. So the potential inflation shocks to China could be very significant the longer this lasts.

Ben-Achour: And how about us, how about in the U.S.? I mean, is this something that could trickle down to pump prices?

Valle: It almost certainly will. We have a more transparent mechanism to move oil prices into pump prices than China would. So it almost certainly will. If, again, the conflict does not escalate from here and Iran doesn't have the strength to retaliate, then it's possible that we'll get prices to come down. [It's] also worth mentioning, that the U.S. has a lot of capacity to grow production at these higher prices. It doesn't have that capacity at $60 oil, but at $75 it certainly can. And that will alleviate some of the impacts on the pump for American consumers.

Ben-Achour: There is a lot of slack in the global oil market in the sense that OPEC could pump more, we could pump more. Does that kind of mitigate the medium-term potential consequences of this conflict?

Valle: Less so for OPEC, because most of OPEC's production growth would come through the Strait of Hormuz, so it doesn't necessarily help you to produce more in that region, specifically. The U.S. does have the capacity to grow production and in fairly short order, enough to alleviate. Combined with strategic petroleum reserves, not just in the U.S., but in China, as well, that can help put a cap on short-term oil prices.