Note: This piece was first posted on Forbes on January 8.
Probably one of the most far-reaching effects of an escalation of the U.S.-Iran conflict could be a shutdown of oil tanker traffic via the Strait of Hormuz by Iran. Though unlikely—given the severity of the consequences—such a move would push international oil markets into considerable turmoil, since approximately 21 percent of globally consumed petroleum passes through the strait. Russia could become a crucial market stabilizer deriving significant financial, strategic, and diplomatic benefits.
Even with a release of IEA strategic stocks, higher crude prices resulting from a shutdown of the Strait of Hormuz would likely affect everyone in a similar fashion. If protracted, the crisis and high oil prices would have a dumping effect on global energy consumption and could result in a global economic slowdown. However, at least in the short term, oil producers could benefit from high prices. Russia, in particular.
One of the reasons why OPEC has had such a great influence on the world’s crude market is its ability to increase (or decrease) production at any given time to dampen potential swings in oil prices. This ability hinges mostly on OPEC’s most powerful member (and not only in terms of crude supply or spare capacity)—Saudi Arabia, which disposes of OPEC’s bulk (and the world’s largest) crude spare capacity, approximately 1.5-2 million barrels per day. With a blockade or severe limitation in traffic in the Strait of Hormuz, Saudi Arabia’s ability to release its spare capacity to the market would be greatly impeded, if not disabled altogether.
In the meantime, Iran (!) and Venezuela, the runners up when it comes to global spare capacity, are unable to step in due to external (sanctions) and domestic issues. Also, U.S. shale producers who would at least in the beginning benefit from high crude prices could not be helpful in the same way Saudi Arabia could. Shale production can respond quickly to changing market conditions—much quicker than conventional crude production—but not as quick as a guarantee of almost an immediate release of additional volumes.
And since U.S. crude production is in the hands of private companies, it is dictated by the market. Hence, it cannot be stopped at a certain price level but will flow until the market saturates. There is also the aspect of U.S. crude quality that differs substantially from Saudi crude. U.S. shale is lower in density (lighter) and sweeter (includes less sulfur) and, as such, cannot immediately act as a substitute.
One country that could potentially have it all is Russia.
Not only does Russia produce the “right” quality of crude (a substitute for the crude potentially locked in by the Strait of Hormuz), but according to a Russian government statement, it holds spare capacity of 500,000 barrels per day. The country cut its oil production due to an agreement with OPEC to prevent oil prices from falling too low in a high-supply environment. With oil prices rising and OPEC generally unable to provide relief, Russia and its oil companies (generally not happy with the production cuts) would surely jump at the opportunity to make the extra buck.
Already after the attack on the Saudi Arabian oil facilities late last year, Russia signaled it would be able to provide additional supplies thanks to new investment its companies have made into new spare capacity. Saudi Arabia was able to regain its import volumes quickly and Russia could not prove this new advantage. If an external factor like the closure of the Strait of Hormuz were to block Saudi oil, Russia would have a real chance to put this new spare capacity to test.
Russia’s leverage in the global oil market has increased in the recent years. The country has become an important partner to OPEC in its struggle to remain the deciding entity to influence oil prices after the U.S. shale revolution unfolded. If OPEC’s crude exports were significantly impaired by Iran-US conflict, Russia would stand to profit handsomely in terms of both actual revenues and in terms of geopolitical influence. Higher prices and production would not only benefit Russian companies but also the Russian budget, given the heavy taxation of the oil industry, especially exports. This aspect is particularly attractive to Russia, as globally crude is traded in U.S. dollars, currency that the country is thirsty for after the U.S.-imposed sanctions on Russian financial institutions following Russia’s invasion of Ukraine and interference in U.S. elections.
Russia also stands to gain geopolitical influence.
Lower diversification of crude supply that a blockade of the Strait of Hormuz would imply, would buttress the perception of Russia as a stable producer and exporter. But while Saudi Arabia has shied away from using its supply beyond regulating market and oil price swings—at least after the 1970s oil crisis—Russia has been less reserved in this matter. After all research shows Russia has repeatedly used its strong bargaining position as oil and gas supplier to extract geopolitical benefits in Central and Eastern Europe.
A blockade of the Strait of Hormuz could potentially strengthen Russia’s position vis-a-vis energy-hungry Asia since about three-fourths of the crude that passes through the Strait lands there. And this is on top of the increasing importance of Russian natural gas that flows to the Chinese market via the newly opened Power of Siberia pipeline. The plot thickens even more when one considers military exercises Russia, China, and Iran have just concluded in the Gulf of Oman.
The law of unintended consequences is hard at work when one considers any type of escalation in the conflict between the U.S. and Iran. And while the Strait of Hormuz has not been blocked yet and may not be blocked any time soon, the option cannot be completely ruled out. Thus, it is important to think through the potential effects that a blockade could have not only on pricing or availability of crude but also on the geopolitical power transfer to a player like Russia—which is already seen as strategic and diplomatic beneficiary of the U.S.-Iran conflict as well as the forced departure of U.S. forces from Iraq.