Monday, 30 March 2015

Will the conflict in Yemen impact oil prices?

The impact of the conflict in Yemen on the oil market is likely to be limited, unless it spreads outside its borders.

Oil prices jumped by almost 5% when the Saudis launched air strikes against Yemen on 26 March. The strikes have raised questions on whether this could cause a significant supply disruption in the oil market. The answer depends on how the conflict unfolds and how widespread it becomes. For this, it is useful to consider three scenarios.

Scenario 1: The conflict stays within the Yemeni borders. This is the most likely scenario. The regional foes have tended to fight their wars through domestic proxies, as in the case of Syria. The scenario promises Yemen years of chaos and misery, but is likely to have little impact on oil prices. With a production of just 150 thousand barrels a day (b/d), Yemen is a small producer accounting for less than 0.2% of global oil supply. Any losses from the Yemeni oil production can be easily replaced with the Saudi excess capacity. And in any case, the oil market is ridiculously over-supplied, so a small loss will hardly be noticed. 

Scenario 2: The conflict spills over in a limited way. This could take the form of the closure of the Bab el-Mandeb Strait. The strait is an important trade route, where 3.8m b/d of crude oil and refined products passed through in 2013, mostly going from the Gulf to the Mediterranean. But the closure of the Bab el-Mandeb Strait does not take this supply out of the market; it just means that the oil tankers have to use an alternative route around Africa. This would add time and transit cost, but the impact on the oil market should still be contained.

In this regard, the strait of Bab el-Mandeb is far less important than that of Hormuz both in terms of oil flow (17m b/d in Hormuz versus 3.8m b/d in Bab el-Mandeb) but also in terms of the availability of alternative routes to bypass each strait (there is not enough pipeline capacity to bypass the strait of Hormuz, while alternative routes exist to bypass Bab el-Mandeb).

The closure of the Bab el-Mandeb Strait is unlikely. There is a heavy presence of international warships in nearby waters as well as an American military base in Djibouti. And if necessary, the Egyptian, Saudi or even the Israeli navy could be deployed to keep the strait open.
Source: Energy Information Administration

Scenario 3: A widespread regional war. This scenario is extremely unlikely. But if it did materialise, it would represent a major shock to the oil market. At risk would be a third of the world’s oil production. However, it is difficult to imagine how an outright war can come about. After all, the regional powers have shown a preference to fight their wars through local proxies and possibly by exporting fighters rather than engage in a direct conflict.

Conclusion. The impact of the conflict in Yemen on the oil market is likely to be limited, unless it spreads outside its borders. The prospect of a regional spillover currently looks unlikely. Perhaps realising this, oil prices declined sharply on the second day of the Saudi strikes, reversing all the gains made on the previous day. 

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