Global energy markets are underestimating the risks to Gulf oil supplies from the escalation in tensions between the US and Iran, say analysts.

The vulnerability of the Gulf oil supplies was underscored in September 2019 when rocket attacks on crude oil facilities in Saudi Arabia’s eastern province took out nearly 6 million barrels a day (b/d) of crude oil supplies.

Riyadh and Washington blamed the attack on Iran. Tehran has denied being responsible.

Perhaps insulated by a slowdown in global energy demand and globally abundant supplies, oil prices rose by only $5 a barrel following the attacks, a roughly 10 per cent hike.

At the same time, Saudi Arabia's national oil company Saudi Aramco was able to tap into its crude stockpile to maintain exports to its key customers and, within weeks, it restored oil production capacity back to to pre-attack levels of 11.3 million b/d.

“This was the worst incident we’ve seen in terms of supply disruptions, and yet the effect was so transitory,” says RBC Capital Markets managing director Helima Croft, who was speaking at the Atlantic Council’s Global Energy Forum in Abu Dhabi on 12 January.

Soleimani assassination

The latest example of the region’s growing instability came on 3 January 2020 when a US drone strike in Baghdad killed major general Qasem Soleimani, commander of Iran's elite Quds Force and one of the Islamic Republic’s most influential military officials.

Tehran responded on 8 January by launching 12 intermediate ballistic missiles against two military bases in Iraq housing US and Iraqi troops.

The carefully choreographed retaliation, which included an advance warning, resulted in no injuries to US or Iraqi military personnel, and appears to have been an attempt by Tehran to de-escalate the crisis.

It did however result in the killing of 176 civilian air passengers when Iranian ground-to-air defence systems erroneously shot down a Ukranian passenger jet that was departing from Tehran.

Tehran’s limited and apparently carefully calibrated initial retaliation to the Soleimani killing took many commentators from fear of a global conflagration and back to relative calm in the space of days. And again, oil prices barely moved.

Flawed response

The response of the energy markets on both occasions was seriously flawed, says Amos Hochstein, senior vice-president of marketing at Tellurian and a former senior energy diplomat in the administration of US president Barack Obama.

“We are back to the same point that Iran is facing crippling sanctions without a clear path out of it," says Hochstein. "It needs to get a clear path out of it. And if we don’t provide one, they will try to create one.”

While some analysts say that Iran's careful response to the Soleimani killing shows that Tehran is seeking to avoid a wider conflict with the US, others say that it will continue to strike at the US and its allies through Tehran-backed proxy forces in Yemen, Iraq, Syria and Lebanon.

And they point out that there is no shortage of attractive targets they could attack.

There is an array of major oil facilities across the Gulf that could be vulnerable to further attacks in Saudi Arabia, Qatar, Kuwait, Bahrain, Oman and the UAE, many of which host US companies, assets and personnel.

Iraq vulnerabilities

Saudi Arabia demonstrated its resilience to disruption following the attacks on the Abqaiq oil processing facilities and the Khurais oil fields in September 2019, but there is little confidence that Iraq’s fragile oil sector could show the same resilience.

In addition, renewed upheaval in Iraq would risk recreating the conditions that allowed the rise of the Islamic State in Iraq & Syria (Isis) militant group, further imperiling Iraq’s infrastructure and paralysing key upstream oil developments.

Iraq is the second-biggest oil producer in the region, with a current output of more than 4.5 million b/d, and has ambitions to boost production capacity to about 7 million b/d over the next decade.

Iraq is a vital contributor to meeting growing future global energy demand.

“I don’t think it’s clear at all that they [Iraq] have the type of redundancies that they could recover from it, again," says Croft. "So I think that we still have to be concerned about the Iranians going back to the more shadow wars in terms of the effects that could have on infrastructure, and Iraq is where I am most concerned."

Some of the lack of panic in the energy markets following the attacks in Iraq and Saudi can be attributed to the increase in US shale oil production, which has helped reduce US dependence on Gulf oil imports.

Mixed signals

Shipments of Gulf oil to the US slumped to about 1.6 million b/d in 2018, compared to nearly 3 million in 2000.

For now, US refineries will continue to import the Gulf’s heavier crude barrels, but the falling imports point to a structural change in the market. And in terms of regional security, they underscore fears in the region that Washington wants to move away from its established relationship with the region, and its unwritten covenant with the Gulf states — the supply of crude in exchange for security.

Many in the Gulf are now asking if they can rely on the US in a time of crisis, if they are no longer necessary for the US economy, Hochstein said.

Washington’s apparent lack of willingness to respond vigorously to the 2019 attacks on Gulf shipping and Saudi Arabia’s Abqaiq oil centre was widely perceived to reflect US President Trump’s desire to disengage from the Middle East. The lack of US military action is said to have put strain on relations between Riyadh and Washington.

The strike on Soleimani shows that the US is prepared to take military action in the region, although it took the killing of a US contractor in Baghdad and violent protesters threatening to storm the US embassy in Baghdad to provoke its response.

It is reported that on the same day that the US drone strike in Baghdad killed Soleimani, a separate airstrike in Yemen attempted to kill Abdul Reza Shahli, an official with Iran's Quds Force who is reported to be an organiser of financing for regional militias supported by Iran.

Maximum pressure

Washington is also ratcheting up economic sanctions on the Islamic Republic as part of its policy to place maximum pressure on the leadership in Tehran.

There will be no let up on the sanctions imposed on Iran’s oil sector, according to Francis Fannon, assistant secretary at the US State Department's Bureau of Energy Resources, who was also speaking at the Atlantic Council’s Global Energy Forum in Abu Dhabi.

US sanctions are having a crippling effect on the Iranian economy, says Fannon, slashing Iranian crude oil and condensate exports and depriving Tehran of “tens of billions of dollars in revenues".

Despite this, it is unclear where President Trump has drawn his 'red lines' for further military action.

Croft for one is not confident that the US would respond to an energy infrastructure attack, particularly if it was carried out by one of Iran’s proxy groups.