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Opinion

India and China cannot rely on US oil as Iran troubles heat up

American shale offers some hope for Asia, but practical problems too

A pump jack operates in an oil field in Texas: U.S. shale output could peak in about a decade.   © Odessa American/AP

The threat to the Asia's vital oil supplies from the Middle East has escalated sharply since four oil tankers were sabotaged in the Gulf of Oman on May 13. A second attack on oil vessels in the region in June, the arrest of a British-flagged oil tanker by Iran's revolutionary guards, and the U.S. and Iran shooting down each other's surveillance drones in the area -- these all point to a protracted problem that could become much worse before it gets better.

But as Asia's biggest oil-consuming economies grapple with the twin challenges of this escalating hostility and losing access to Iranian crude under U.S. sanctions, their solution -- seeking refuge in increased imports from the U.S. -- is a risky strategy.

American oil is a welcome new option for diversification, but hardly a replacement for the fraught supplies from the Middle East in terms of quality, long-term security or cost of supply.

Much of the recent trouble centers on the Strait of Hormuz, a narrow strip of water adjoining Iran that connects the Persian Gulf with the Gulf of Oman. It is the world's most important oil transit choke point, with 21 million barrels per day of oil, a fifth of the world's consumption, flowing through it in 2018. Nearly three-quarters of those shipments came to Asia.

To increase their resilience in case of disruption here, China, India, Japan and South Korea, Asia's largest oil consumers, have all ramped up their crude purchases from the U.S., especially since 2018. The recent peak of cumulative U.S. crude exports to China, India, Japan and South Korea was just under 1 million barrels per day, recorded in December 2018.

A speedboat of the Iran's Revolutionary Guard moves around a British-flagged oil tanker Stena Impero on July 21, which was seized by the Guard.   © Mizan News Agency/AP

But these volumes are relatively modest. Nearly half of the 21 million barrels per day of crude imported by the four countries in the first half of this year were from the Middle East.

There is much more oil available for the global market from the Middle East than the U.S. on a regular basis. Saudi Arabia, Iran, Iraq, Kuwait, Qatar, UAE and Oman collectively pump about 22 million barrels per day of crude oil, and export around 17 million barrels per day.

By contrast, U.S. output was just under 12 million barrels per day in the first four months of 2019, of which an average of only 2.8 million barrels per day was shipped overseas.

There is a difference in quality too. U.S. crude from the shale regions is predominantly light and low-sulphur. Middle Eastern producers mostly pump heavier and higher-sulphur grades, which are the baseload of the typical Asian refinery's diet and are relatively cheaper.

Finally, simple geography makes U.S. supplies less convenient, with attendant expenditure and logistical costs. U.S. crude cargoes are shipped from terminals in the Gulf of Mexico and travel a longer distance to reach Asian destinations, incurring higher freight costs compared with Middle Eastern barrels.

Most operations to fill up a Very Large Crude Carrier require ship-to-ship transfers in the deeper waters of the U.S. Gulf, away from the shallow terminals. A VLCC offers economies of scale compared with smaller oil tankers, but the additional logistics for filling it up in the U.S. raise the final cost for the buyers.

Asian importers also need to think about the future of their crude supply sources. While producers across the Middle East hold plenty of proven conventional oil reserves and spare production capacity that guarantees long-term supply for buyers, U.S. shale production growth is already slowing down and output could peak in less than a decade.

The world is still learning about hydraulic fracturing and shale behavior, and an unexpected sharp decline in U.S. output could leave importers with increased dependence on the oil stranded.

Besides the U.S., there are hardly any producers outside OPEC's Middle Eastern members with the ability to sustainably raise output. Russia, Brazil and Canada are among the few, but have limited ability to boost production and to transport it to overseas markets.

Meanwhile, the fact that major powers including the U.S., U.K. and Russia are advocating different approaches and initiating discrete efforts to tackle the Persian Gulf security issue does not offer much comfort.

Complicating matters further, Iranian President Hassan Rouhani has warned foreign powers to keep their navies out of the region, insisting that safeguarding the Strait of Hormuz and waters around it is the responsibility of the countries in the region. However, deep-rooted regional rivalries rule out a coordinated effort by the littoral states.

The U.S., U.K. and India have already individually beefed up their naval presence in the region to ensure safe passage for their commercial ships. Japanese shipowners have variously advised ships to stay clear of the Iranian coast and speed up while transiting the Strait of Hormuz.

China has remained officially silent on the subject, while South Korea is preparing to deploy a naval unit in the region. The U.K. is keen on a new European maritime alliance to protect commercial shipping in the strait.

The U.S. administration is trying to forge a coalition with allies in Europe, Asia and the Middle East to increase surveillance and escort ships in the Middle East. The targeted time frame and other details of the plan, dubbed Operation Sentinel, are not yet known. How it would fit in with other individual and regional plans is also unclear.

Asia's economic powers need to realize that increased dependence on U.S. shale is only a partial response, at best, to the risk hanging over their supplies from the Middle East.

As major stakeholders in the stability of the Persian Gulf region, they need to take charge, agree on a collective diplomatic or naval response to the situation among themselves and with the U.S., U.K. and the Middle Eastern governments, and quickly set it in motion.

Vandana Hari is founder of Singapore-based Vanda Insights, which tracks energy markets. She has two decades of experience providing intelligence on the energy sector.

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