Analysis: Three Scenarios For A Strait Of Hormuz Closure

The rhetoric has been flying this week between U.S. President Donald Trump and Iranian President Hassan Rouhani. Trump as much as threatened nuclear annihilation on the Islamic Republic in a caps filled Tweet in response to Rouhani telling a gathering of diplomats in Tehran that war with Iran would be “the mother of all wars.” The U.S. president chose to ignore the second part of the Iranian president’s sentence in which he added “… and peace with Iran is the mother of all peace.”

The talk of war heated up in early July, when Rouhani hinted that Iran may close the Strait of Hormuz, oil’s most important maritime choke point, in response to the U.S. government attempting to impose a global oil embargo against Iran through a combination of primary and secondary sanctions — potentially an existential threat to the regime, since oil is key to the country’s economy. Shortly thereafter, Iranian Revolutionary Guard commander Mohammad Ali Jafari, whose forces patrol the Strait of Hormuz, warned “either everyone or no one can use the Strait of Hormuz.”

A spokesman for U.S. Central Command (CENTCOM), Bill Urban, responded immediately, saying Washington and its allies are prepared to respond militarily to keep tanker traffic moving through the Strait of Hormuz. Based on international maritime law, any deliberate military disruption to commercial traffic is an act of war.

What is the likelihood of Iran attempting to close the Strait of Hormuz? How effective would such an action be? What would its impact be on global oil prices?

Likelihood of closure

The likelihood of Iran attempting to close the Strait of Hormuz is more than a long shot — and hence, significantly greater than most analysts predict — since the goal of the Trump administration is at minimum drastic behaviour change of the Islamic Republic, and at maximum regime change. The budding Trump-Saudi-Israel alliance, and key U.S foreign policy officials such as Secretary of State Mike Pompeo and National Security Advisor John Bolton, appear to favour the latter.

At the Heritage Foundation in Washington in his first public address as secretary of state in late May, Pompeo laid out America’s strategy for dealing with the Islamic Republic. He said the U.S. would work with allies to thwart Iran’s ambitions in the Middle East, while imposing “the strongest sanctions in history” on it to do so.

Pompeo did not negate the possibility of a new nuclear deal, with Trump pulling the U.S. out of the 2015 Joint Comprehensive Plan of Action (JCPOA) earlier in May, but acceptance of the American government’s 12 conditions for negotiations — including a permanent end to uranium enrichment; halting development of nuclear-capable missile systems; withdrawal of Iranian military forces from Syria; ending support for Hezbollah in Lebanon, the Houthis in Yemen, and Shiite militias in Iraq; and stop threatening to destroy Israel and harm other U.S. allies in the Middle East such as Saudi Arabia — would neuter Iran as a regional power, and as a result, it is highly doubtful the Islamic Republic would ever voluntarily agree to them.

On the other hand, Pompeo made a thinly veiled call for regime change during the question-and-answer session following his Heritage Foundation address, when he said: “At the end of the day, the Iranian people will decide the timeline.… If they make the decision quickly, that would be wonderful.”

A minor U.S. official, Brian Hook, director of policy planning at the State Department, provoked Rouhani to make his implicit threat regarding the Strait of Hormuz when he said on July 2 that Washington’s goal is to “increase pressure on the Iranian regime by reducing to zero its revenue from crude oil sales.”

On July 16, Treasury Secretary Steve Mnuchin appeared to partly backtrack on this hardline position, when he said some countries might be granted temporary exemptions on U.S secondary sanctions on importing Iranian oil — to come into effect on Nov. 4 — but with Trump in charge one never really knows until the end.

If the U.S. government decides on a relatively hardline approach on sanctions and they prove effective, for example, by slashing Iran’s 2.7 million bbls/d of crude and condensate exports by substantially more than half (see Crude Oil Prices to the Stratosphere?), there is a fair chance that the Islamic Republic would, in desperation, attempt to close the Strait of Hormuz to maritime traffic.

The memory remains remarkably fresh in Iran of the 1951-53 oil embargo that toppled the democratically-elected government of Prime Minister Mohammed Mossadegh and the CIA installing the despot Mohammad Reza Pahlavi, the so-called Shah of Iran, in his place. In addition, as recently as last winter, the Islamic Republic suffered large-scale anti-government protests for a combination of economic and environmental reasons, and that was with the country’s oil exports at full throttle.

Effectiveness of closure

The leadership of the Iranian Navy and the Revolutionary Guard Navy — two separate organizations — knowing they could never challenge the U.S. in a conventional naval contest, have been accumulating considerable asymmetric and other capabilities to enable the Islamic Republic to close the Strait of Hormuz since the “tanker war” in the Persian Gulf during the 1980-88 Iran-Iraq War. These capabilities include thousands of sea mines, torpedoes, advanced cruise missiles, regular-sized and mini-submarines, and a flotilla of small fast-attack boats, most of which are concentrated in the strait region.

Pentagon planners believe Iran would use all of these capabilities in an integrated fashion to both disrupt maritime traffic in the Strait of Hormuz and attempt to deny American and allied forces access to the region. Iranian naval forces are viewed as a “credible threat” to international shipping in the strait.

When commanding CENTCOM between 2010 and 2013, now-Secretary of Defense Jim Mattis developed a multinational plan to minimize disruptions to maritime traffic in the Strait of Hormuz by preventing Iranian efforts to lay mines and systematically clear mines that have been deployed — assumed to be the major means to hinder traffic as it is difficult to sink a modern double-hull oil tanker by torpedo or missile attack. A primary goal of the plan is to create ever larger safe passages through mine fields to allow the movement of oil tankers to return to pre-crisis levels as quickly as possible.

There is consensus among U.S. military planners that American and allied forces would ultimately prevail over Iran if it attempted to close the Strait of Hormuz. The most optimistic planners believe U.S.-led forces could reopen the straight within a few days, whereas the least optimistic ones believe it could take up to three months to restore maritime traffic to normal levels.

The wildcard is hostilities spreading from the Strait of Hormuz to elsewhere in the Persian Gulf region, in which case oil and gas production and export infrastructure could suffer significant damage. For example, if U.S. and allied forces attack Iranian military and missile bases not just in the strait region, but elsewhere in the country as well — to further decrease its ability to hinder mine-removal or countermine activities, for example — the Islamic Republic may choose to launch airstrikes and missiles on American regional allies such as Saudi Arabia and the UAE while it still has the capability to do so — in a nutshell, use them before it loses them based on Saddam Hussein’s experience in Iraq.

Three scenarios

The impact of a closure of the Strait of Hormuz on global crude prices obviously depends on the amount of oil kept off the world market on a daily basis and the duration of the disruption. Based on the discussion in the previous section, we explore two scenarios that relate directly to the Strait of Hormuz, and a third one that includes the war spreading elsewhere in the Persian Gulf.

In the Optimistic Scenario, where the Strait of Hormuz is only closed to commercial traffic for a few days, the impact on global oil supplies would be relatively minimal, but we would still see a brief spike well above US$100/bbl due to the initial uncertainty surrounding its outcome. Crude prices would then quickly fall back to pre-crisis levels.

The flow of roughly 18.5 million bbls/d of oil and product would be curtailed if the Strait of Hormuz is fully closed, but this would be mitigated by almost 4 million bbls/d of crude being shipped on currently spare pipeline capacity across Saudi Arabia to Red Sea export facilities and the Abu Dhabi Crude Oil Pipeline bypassing the Strait of Hormuz. In addition, Saudi Arabia has stored an undisclosed, albeit relatively small amount of crude oil in a number of storage facilities around the world, including Rotterdam in Europe, Okinawa and China in Asia, and the U.S. Gulf Coast.

Under the Pessimistic Scenario, the world’s oil emergency response system would be taxed to its maximum in the first two months of the crisis — assuming the Strait of Hormuz is fully closed for the first 45 days, and a straight line resumption in oil tanker traffic over the next 45 days — leading to historically high crude oil prices on an inflation adjusted basis for an extended period.

Global strategic oil reserves would be more than enough to cover the shortfall in an overall sense, with about half the 1.9 billion bbl total remaining post-crisis, but the rate of daily withdrawal from strategic reserves would pose a challenge. Previous studies suggest that a maximum of 14.4 million bbls/d of crude and product could be released from International Energy Agency (IEA) member country reserves in the first month and roughly 12.5 million bbls/d in the second month, compared to disruptions of 14.6 million bbls/d and 13.3 million bbls/d, respectively, based on our assumptions. China and India now account for almost a fifth of global strategic reserves, and releases from their reserves would contribute to IEA efforts — whereas commercial inventories around the world now tend to run on a just-in-time basis.

Based on a recent study by the King Abdullah Petroleum Studies and Research Center (KAPSARC), in a world without spare crude capacity — which in effect would be the case with the Strait of Hormuz closed — oil prices would have spiked above US$325/bbl at the height of the Libyan Crisis in June 2011. For the sake of scale, a mere 60 million bbls was released from IEA country stockpiles during that crisis.

Finally, in a Wildcard or Nightmare Scenario, in which there is significant damage to Persian Gulf oil producing and export infrastructure as well as a three-month closure of the Strait of Hormuz, crude oil prices would rocket to the stratosphere. They would not begin to fall back until the global economy falls into a deep recession. A direct hit on Saudi Aramco’s Abqaiq oil processing facility alone could deprive the world market of 7 million bbls/d for a year or more as the plant is repaired.

The impact of this and other Persian Gulf production losses could be mitigated somewhat by the remaining half of the world’s strategic reserves, as well as 300 million bbls/d of crude that Saudi Arabia holds in reserve at home assuming Saudi export facilities remain relatively intact. Fortunately, the Nightmare Scenario is less likely than the other two.