Oil flow won’t be affected by current Yemen campaign

Yemen’s strategic location, from a crude movement point of view, appeared contributing to the initial reaction of the markets to the events of the past week.

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Leaping oil markets began fading as the eventful week came to a close. Earlier, in a knee-jerk reaction to the conflagration in Yemen, crude markets jumped by about 5 percent on Thursday, the biggest daily gain in a month. Markets appeared panicking. Benchmark Brent oil neared the $60 a barrel mark, while the U.S. West Texas Intermediate (WTI) crude soared above $50, approaching 2015 highs.

This was overreaction. The spike was sparked by fears action in Yemen could disrupt world crude supplies. Some hinted at the possibility of a spillover into the neighboring countries. This was despite the fact that Saudi Arabia made it clear that there were no plans of a land offensive at the moment. “There are no immediate plans to launch ground operations in Yemen,” the Saudi military spokesman told a press conference.

And in order to avoid any aftershocks, Riyadh announced strengthening not only security at borders but also around oil and industrial facilities. At a meeting to review security developments in Yemen, Deputy Crown Prince Mohammed bin Naif, who is also the interior minister, stressed on “strengthening all security measures on the borders of the Kingdom and in all public utilities and around the oil and industrial facilities”, SPA reported. Kuwait too has reportedly boosted security around its oil sites.

The markets got alarmed despite the fact that Yemen is not a major oil producer. And its output was going down - even further - over the last few years, producing just around 130,000 bpd in recent months. That’s insignificant to have any real impact on the global crude balance. Yet the markets panicked.

Yemen’s strategic location, from a crude movement point of view, appeared contributing to the initial reaction of the markets to the events of the past week. Besides being a neighbor to the most important oil producer in the world, Yemen is also located along the oil trading chokepoint of Bab el Mandeb, a sliver of water that connects the Red Sea to the Gulf of Aden.

The waters between Yemen and Djibouti, known as Bab el-Mandeb, are less than 40 kilometers wide, and considered by the US Energy Information Administration to be a “chokepoint” for global oil supplies. The passage connects oil tankers from the Mediterranean to the Indian Ocean. Crude carrying vessels need to pass through the Yemen coastline via the Gulf of Aden to get to the Suez Canal, a key passageway to Europe.

As per the EIA estimate, some 3.8 million barrels per day of crude passed through Bab el-Mandeb in 2013. And the “closure of the two-mile strait would force tankers to sail around the southern tip of Africa to reach European, North American, and South American markets,” the US Department of Energy says. If the corridor is blocked, the alternative route via the Cape of Good Hope would raise tanker costs to $150,000 from $45,000.

But is that a real threat in the current setup? After all, the US Navy routinely patrols the region. And additionally Egypt has sent naval vessels to help secure the passage. And this is despite the fact that the adversaries - the Houthis - do not exactly have a strong maritime presence. The conflict hence is likely to remain onshore.

And any spillover from into neighboring borders also doesn’t seem feasible at this stage. Land forces are not in operation - at least - as yet. And in the meantime, not only the borders have been secured further, there are also hints that allies may also join in to protect the Saudi borders. Already Pakistan has hinted that the security of Saudi Arabia is of strategic importance to Islamabad. And it would go to any extent to protect it. Egypt in the meantime, has also indicated it would be ready to send in forces, indeed if and when required and solicited.

Additionally, another thing that needs to be underlined here, from crude viewpoint, is that oil installations of the Kingdom are not only fully secured, they are thousands of kilometers away from point of action. Any disruption in crude flow, thus at best, remains a farfetched idea at this moment.

And it is perhaps in this perspective that most analysts think of the current spike to be a temporary –short-lived - phenomenon only. Some analysts are attributing some of last week’s rally to short covering after steep losses in early March, underlining the gains should be brief as worries about a supply glut continue to linger in the market.

“You don’t want to be short oil when there are stories about bombings next door to Saudi Arabia, even if it’s the Saudis who are leading the charge,” Joseph Posillico, senior vice president of energy futures at Jefferies in New York was quoted in the press as saying.

“But with shorts squeezed out of the market, particularly those under $50 WTI, we are reassessing where to go. I personally don’t think this rally has legs as fundamentally nothing’s changed.”

There’s no need for markets to overreact as Yemen is not a significant player in the oil industry, writes Nick Cunningham. The surge comes amid growing concerns of oil overflowing storage tanks in the US and around the world, which threaten a new round of weakness in oil prices, he emphasized.

The markets are overreacting. Yemen is a negligible oil producer, and any disruption to its output would hardly be noticed on the global markets. Not only does Yemen produce very little oil, but its production has already been declining for much of the last 15 years.

And this possibly means that once the initial shock of the ongoing conflict wears off, oil prices will likely pare back their gains, with markets refocusing on weak fundamentals. Crude oil storage at Cushing is three-quarters full. China’s strategic petroleum reserve is nearly full. US refineries are temporarily closing for spring maintenance. All of these things will push the price of oil back down. That however will need to be weighed against falling rig counts and perhaps the beginning of oil production declines in several key shale areas in the United States, Cunningham points out.

“Just because Saudi Arabia and others conducted air strikes doesn’t mean the oil market becomes suddenly tight,” Masak Sumetsu, manager of the energy team at Brokerage Newedge in Tokyo, told Reuters.

There is indeed little rationale for the oil markets to be rattled at this stage. Despite the current spike, sooner, rather than later, normalcy is bound to prevail and markets to get back to routine.

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