Saudi Arabia began airstrikes in Yemen last week, a move that has enormous ramifications around the world, not just the region, particularly in the ways it will affect the commodity markets in the UK. Oil spiked 5% on the news, the most in a month. This article shall look at the reasons why this will affect us, the rationale behind Saudi Arabia’s decision, and the future scenarios in store for oil given the current situation.
Yemen is of great strategic importance to the global oil and gas world, not because it is a major producer, but because it is quite the opposite. Yemen is the 32nd biggest exporter in the world and 16th for liquid natural gas. Its oil and gas production have been in strong decline in the last few years, which can be argued is part of the reason for the unrest. A significant portion of Europe’s supply of oil and liquid natural gas shipments pass through the Bab-el-Mandeb strait, the 18 mile wide body of water between Yemen and the African continent through which ships pass to and from the Suez Canal.
Any disruption to the daily supply chain through the strait can cause supply shortages and prices rises. The alternative route is to go south around the Cape of Good Hope in South Africa, however, this would make the journey twice as long. As this presents a possibility of disruption, the markets have rallied. Welcomed by many producers, the price of oil rose by over 4.7% that week, the biggest gain in the month.
Why have Saudi and some of its allies joined forces in conducting airstrikes? There is a significant concern that it is Iran who is backing the rebels and is trying to gain influence in the region, a theory that they strongly dismiss. Saudi’s are staunch opposers of Iran and will do anything to stop Iranian influence or growth, the battles in Yemen are seen to be a proxy war with Iran.
Views on the airstrikes are mixed, many in the Middle East have supported them, but the foreign policy chiefs of Lebanon, China, Russia, and the EU have all stated that air strikes are not the solution. Indeed, history has taught us that airstrikes aren’t particularly effective and that a focus on economic prosperity is the way to go as it creates stability. Despite this, there is still a strong likelihood of Saudi troops invading Yemen. To date, there has been no record of Saudi Arabia using its military directly. Usually, threats to cut financial aid or the supply of oil to a region were enough in the past, ground invasion certainly sends a strong sentiment.
Along with the situation in Yemen, the US, EU, and Iran could do without the negative attention coming from speculation regarding the airstrikes. Iran is very close to having its economic sanctions lifted, with discussions taking place presently in Switzerland to discuss terms. The Russian gas reliant EU could also do with Iranian sanctions being lifted as Iran has some of the largest gas deposits in the world but is not allowed to get them out of the ground. Calls to initiate pipelines carrying Iranian gas to the EU in order to decrease reliance on Russia are very viable and only possible if the deal in Switzerland works
What does this mean for oil prices in the medium term? There has been much speculation of oil going down to $20/barrel or lower. This is based on the continuing surge of oil being placed into storage as demand continues to dwindle. Oil in US storage facilities has reached record highs. Due to this, many US oil companies have defaulted on their debt repayments, and, despite the US oil producers folding month on month with a near 50% drop in rig counts, oil prices keep going down.
The renewed volatility in the Middle East, one of the previous drivers for rising oil prices, has now caused prices to increase again. Depending on how long airstrikes continue and if troops are sent into the area, there will be a direct impact on how long the price of oil will continue to rise. It is in the oil producers’ interests that the airstrikes continue as this will mean a rise in oil prices. The fact that nearly all the oil producers in the region are for airstrikes and Yemeni rebels have no real capability to disrupt supplies poses questions to be asked regarding the real motive of the strikes.
Overall, new tensions in the Middle East are not good news no matter the perspective. The only winners in this are the oil producers who may have a short term rise in profitability, but the price of oil would quickly withdraw once supply concerns have been subdued. The global oversupply, as well as Iranian sanctions potentially being lifted, will ensure oil remains low for the time being. Should any disruption threat occur, only then we will see the spike.