Understanding the Real Threat to Oil Production in the Middle East

Re-Blogged From Stratfor

The last three weeks have brought the world’s biggest oil-producing region back into the headlines. From a crisis in the Gulf Cooperation Council (GCC) to the political aftermath of a terrorist attack in Tehran, recent developments have renewed concerns that turmoil in the Middle East could cause havoc in the international oil market. Despite the heightened commotion, however, these concerns are misplaced. More than regional tension, the Islamic State’s activity in southern Iraq — and perhaps southern Iran — presents a serious threat to energy production.

Testing the OPEC Deal

The falling out between Qatar and its fellow members of the GCC is unlikely to derail the production cuts that OPEC recently extended in an effort to curb oversupply and rebalance the market. Tension is running high between Iran and the GCC, as well as among the bloc’s members, but oil producers on both sides of the Persian Gulf have long been willing to lay aside their differences in the interest of managing energy markets. As Riyadh tries to persuade the U.S. administration to coerce Qatar into following the Saudi regional agenda, it is no less focused on steadying the oil market to keep its economic reforms on track and preserve domestic stability.

The GCC’s current campaign to isolate Qatar poses a greater threat to the country’s economy than the fallout of its 2014 spat with the bloc did. Saudi Arabia and the United Arab Emirates have led the charge to sever trade and travel ties with Doha while enacting aggressive measures such as a policy barring Qatari vessels from using Saudi or Emirati ports. In addition, Qatar, the world’s largest liquefied natural gas (LNG) producer, will have to adapt its strategy now that its state-owned natural gas carriers are banned from using bunkering locations in Saudi Arabia or the United Arab Emirates. Meanwhile, because Qatari crude is often loaded onto ships alongside oil produced elsewhere in the Gulf, oil traders will have to get creative in how they ship Qatari crude to consumer markets. Some of their options include using smaller vessels to ship oil directly to destination markets, using smaller vessels to stock larger ones via ship-to-ship transfers, or co-loading with other Gulf producers such as Oman and Kuwait. Ultimately the bans will not take Qatari crude and LNG completely off the market, but they will hike up shipping costs. Egypt, for its part, has refrained from closing the Suez Canal or Sumed pipeline to Qatari crude and LNG, probably because the move would interfere with its contractual obligations to shipping companies.

At the same time, Qatar is actively trying to defuse the crisis with its neighbors, rather than inflaming it further by, for instance, withdrawing from the OPEC production deal. (Besides, since the country contributes only about 30,000 barrels per day to the cut, pulling out of the agreement wouldn’t have a dramatic effect.) The extent to which Doha resists Saudi and Emirati pressure to change its ways will depend on how secure it feels in its security relationship with the United States. Though U.S. President Donald Trump has expressed staunch support for Riyadh and Abu Dhabi’s agenda against Doha, U.S. military and diplomatic officials have offered Qatar ample reassurances. Trump, moreover, has since phoned the Qatari emir and called for unity among the GCC’s members.

The Aftershocks of an Attack

The terrorist attacks that shook Tehran on June 7 also raised concerns about the oil market. Since the Islamic Revolutionary Guard Corps (IRGC) insinuated that Saudi Arabia and the United States were tied to the incidents, questions have swirled over whether Iran’s response would destabilize the oil market. The statements served a political purpose. The IRGC has been worried that Iranian President Hassan Rouhani’s recent re-election would empower him to neutralize its economic and security clout. In the wake of the attacks, the IRGC will use the security threats facing the country to justify expanding its covert activities abroad against Saudi Arabia, the United States and their allies.

But the chances of a conventional military conflict that could restrict commercial traffic in the Strait of Hormuz are slim. The same considerations that stayed Iran’s hand when it was under the threat of military attack for its nuclear program will factor into its calculations over the costs of triggering a conflict today. The IRGC could increase its naval activities in the Strait of Hormuz to harass the United States’ vessels and those of its allies. Tehran will take care, however, to avoid a scenario in which Washington increases its sanctions on Iran or jeopardizes its economic recovery.

A Greater Danger

Instead, as tensions between Iran and Saudi Arabia mount, their proxy wars will likely intensify. These conflicts pose little risk to energy supplies. The Shiite dissidents Tehran supports in Saudi Arabia’s oil-rich Eastern Province, for instance, have yet to prove themselves capable of an attack on energy infrastructure that would take Saudi oil production offline. Their activities have so far focused on security checkpoints and soft targets. Iran, meanwhile, will be on heightened alert for evidence of external meddling on its borders, especially in the dissident areas of Iranian Kurdistan, Sistan-Baluchistan and Ahvaz. Ahvaz, home to a large concentration of Arab dissidents, is the capital of Khuzestan province, where the vast majority of Iran’s oil is produced. But the region’s separatist movement is a manageable threat, and Sunni powers such as Saudi Arabia haven’t had much success trying to turn their local proxies into a formidable enemy of the Iranian state.

The threat of jihadist terrorism, on the other hand, may be a different story. Iran has now suffered a spectacular attack at the Islamic State’s hand, and the extremist group presents a threat to oil production in the country and beyond. Iraq’s oil infrastructure is particularly vulnerable. As the Islamic State comes under greater pressure in Iraq and Syria, it will divert its energy and resources from holding territory to coordinating terrorist activities. The group has focused its most significant attacks in Iraq on the country’s capital and predominantly Shiite areas. But on May 19, the Islamic State claimed responsibility for an attack on two checkpoints near the oil fields in Basra. If the group were to target onshore oil and natural gas infrastructure in southern Iraq — a region that produces most of Iraq’s oil and exports 3.2 million bpd — it could disrupt energy markets worldwide.

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