Oil prices have been fluctuating in the past few weeks amid rising geopolitical tensions in the Middle East, where the war between Israel and Hamas has escalated into a wider regional confrontation. The Red Sea, a vital waterway for global trade and energy supply, has become a hotspot of violence and uncertainty, as the US and UK launched airstrikes against Houthi rebel sites in Yemen in response to attacks on shipping and military vessels. The world’s largest shipping lines have paused shipments through the Red Sea, diverting cargo around the Cape of Good Hope on the southern tip of Africa, adding thousands of miles to journeys and driving up costs and delays. Economists warn that the disruption to shipping and higher oil prices, if sustained, could undermine the global economic recovery from the Covid-19 pandemic and the energy crisis triggered by Russia’s invasion of Ukraine in 2022.
The impact of the Red Sea disruption on oil prices and supply
The Red Sea is one of the most important maritime routes in the world, connecting the Mediterranean Sea with the Indian Ocean and the Persian Gulf. About 10% of global oil trade passes through the Red Sea, mainly through the Suez Canal and the SUMED pipeline, which link the oil-producing countries in the Middle East and North Africa with the European and Asian markets. The Red Sea is also home to the Bab el-Mandeb Strait, a narrow chokepoint that controls access to the Gulf of Aden and the Horn of Africa, where piracy and instability pose additional threats to shipping.
The recent attacks on shipping and military vessels in the Red Sea have raised fears of a potential closure or disruption of the waterway, which could have severe consequences for the global oil market. According to the International Energy Agency (IEA), a closure of the Suez Canal and the SUMED pipeline would divert about 5.5 million barrels per day (mb/d) of oil, or about 6% of global supply, around the Cape of Good Hope, adding 15 days and $0.26 per barrel to the journey. A closure of the Bab el-Mandeb Strait would divert about 4.8 mb/d of oil, or about 5% of global supply, around the Cape of Good Hope, adding 10 days and $0.16 per barrel to the journey. The IEA estimates that the total cost of such diversions would be about $9 billion per month.
So far, the disruption to the Red Sea has had a muted impact on oil prices, as the market has been able to absorb the additional costs and delays. Oil prices have been under downward pressure in recent months, due to weak global demand, record output from the US, and steady production and exports from Russia and OPEC+. The price weakness has persisted despite the extension and deepening of production cuts by OPEC+ and the announcement of oil purchases by the US government to replenish its Strategic Petroleum Reserve. Oil prices averaged $78/bbl in December, down from $94/bbl in September, reversing all the gains accrued in 2023Q3. Brent crude prices hit $80/bbl on Friday, but quickly retreated as traders weighed an ambiguous US inflation report and the prospect of easing tensions in the Middle East.
However, some analysts warn that the oil market is too complacent about the rising geopolitical risks, and that prices may need to rise by 15% to reflect the true cost of the Red Sea disruption. They argue that there is no sign of a resolution to the conflict in the Middle East, as the war between Israel and Hamas may be drawing in larger oil disruptors, such as Iran and Saudi Arabia, and that the US and UK airstrikes against the Houthis may provoke further retaliation. They also point out that the Red Sea disruption could exacerbate the existing supply-demand imbalance in the oil market, as the diverted oil would take longer to reach the consumers, creating a temporary shortage in some regions and a surplus in others. They suggest that the oil market may be underestimating the potential for a supply shock, as the spare capacity of OPEC+ and the US is limited and the strategic reserves are not sufficient to cover a prolonged disruption.
The implications of the Red Sea disruption for the global economy and trade
The disruption to the Red Sea is not only affecting the oil market, but also the global economy and trade, as the waterway is a key conduit for the movement of goods and commodities. According to the World Bank, about 8% of global trade passes through the Red Sea, mainly through the Suez Canal, which handles about 19,000 ships per year, carrying about 1.2 billion tons of cargo, worth about $1.5 trillion. The Red Sea is also a major route for the transport of liquefied natural gas (LNG), coal, iron ore, grains, and other commodities, as well as manufactured goods, such as cars, electronics, and textiles.
The diversion of shipping around the Cape of Good Hope is adding significant costs and delays to the global trade flows, as the journey is about 6,000 km longer and takes about two weeks more than the route through the Red Sea. The diversion is also increasing the demand for fuel and the emissions of greenhouse gases, as well as the risk of accidents and piracy. The shipping industry is facing higher freight rates and lower profitability, as the capacity and availability of vessels and containers are reduced. The consumers and businesses are facing higher prices and lower quality, as the delivery of goods and components are delayed and disrupted.
The impact of the Red Sea disruption on the global economy and trade is difficult to quantify, as it depends on the duration and severity of the disruption, as well as the resilience and adaptation of the supply chains and the demand conditions. However, some economists have attempted to estimate the potential effects, using various scenarios and models. For example, Ana Boata, the head of macroeconomic research at Allianz Trade, said that the disruption could push inflation up by 0.7 percentage points in Europe and the US, while sapping a similar amount from economic growth on both sides of the Atlantic. She said that the disruption could also affect the global trade growth in volume, increasing the risk of a delayed rebound from the 2023 recession. Sources close to the UK Treasury said that they had modelled various scenarios for the potential impact on Britain, including crude oil prices rising by more than $10/bbl and a 25% increase in natural gas prices. They said that they were concerned that the disruption could damage Britain’s economy, as it struggles for growth amid the cost of living crisis.