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US-Iran crisis poses fresh and enduring risk to Middle East oil supply

China, India and Japan need to take diplomatic initiative as big importers from Gulf

| Iran
Iranian military forces drill in the Strait of Hormuz in December 2011: Iran may carry out its threat of blockading.   © Reuters

Although the U.S. and Iran had come close to military confrontation in 2019, they stepped back from the brink at the last minute, much to everyone's relief. The U.S. assassination of top Iranian military leader Qassem Soleimani in the Iraqi capital of Baghdad in the early hours of January 3, however, may have pushed the situation beyond retrieval.

This has put the volatile Middle East on the edge and raised the specter of major disruption to oil supplies from the region, which produces nearly a quarter of the world's needs. China, India, Japan and South Korea are heavily reliant on imports from the Gulf, meaning any crisis in the Middle East is going to affect Asia's biggest economies quickly and for the long term.

The oil market had begun to discount the worst-case scenarios by January 7 in the absence of any immediate military action by Iran or its proxies, but was forced to reconsider after Tehran launched missiles on two U.S. air bases in Iraq early the following day.

Even if the U.S. decides against picking up the gauntlet this time around, it might be too soon to be lulled into a sense of relief.

For one, this time the conflict has sucked in Iraq. The U.S. airstrike on January 3 also claimed the life of top Iraqi paramilitary commander Abu Mahdi al-Mohandis and infuriated the government in Baghdad, which said the action violated its sovereignty.

For Iraq to be caught in the middle of the U.S.-Iran conflict this time around is especially lamentable. The country, only recently freed from the scourge of the Islamic State terrorist group, is already mired in deep political crisis, with a caretaker government besieged by violent protests against state corruption and mismanagement since last October.

The second-largest producer in the Organization of the Petroleum Exporting Countries after Saudi Arabia, Iraq pumps around 4.6 million barrels per day of crude and had managed to keep it flowing despite attempted disruptions by the demonstrators. But if its bases housing 5,000 U.S. troops become a target of intensified Iranian attacks, Iraq could implode, taking its vibrant oil sector with it.

Demonstrators carry an Iraqi flag outside the U.S. Embassy during a protest to condemn air strikes in Baghdad on January 1.   © Reuters

The Iraqi parliament responded to the deaths of Soleimani and Mohandis by passing a resolution to expel U.S. troops from the country. The directive, though nonbinding on the government, exposed Baghdad's precarious position in trying to balance the interests of the U.S. and Iran, a neighbor with which it has strong political and commercial ties.

While the global oil market has been able to absorb the loss of substantial production from Iran and Venezuela following crippling U.S. sanctions against those countries, it would be in for a major shock if Iraq were to meet a similar fate.

Meanwhile, Tehran has dealt global diplomacy a major blow by withdrawing all its commitments on uranium enrichment -- which could help it to develop nuclear weapons -- made under a landmark agreement signed with major world powers in 2015. Iran says it has been developing such technology only for peaceful purposes, but a nuclear Iran would further destabilize the Middle East.

An isolated and infuriated Iran may finally carry out its threat of blockading the Strait of Hormuz, the narrow body of water separating it from the Arabian peninsula, one of the world's most vital conduits for oil and gas shipments and a vulnerable choke point.

If Tehran or its proxy militias in the region proceed to launch multiple attacks on oil infrastructure like the ones on Saudi Arabia's Abqaiq and Khurais oil fields last September, which shut off nearly 60% of the kingdom's production, the world may be left without an adequate buffer to tide over the outages.

The latest rise in tensions in the Middle East risks another hike in insurance premiums for oil tankers plying the Persian Gulf, dealing a double whammy to refiners already forking out higher prices for crude.

The increased costs will hit Asia especially hard. India is particularly vulnerable as the only country among the region's top four consumers without strategic oil reserves to act as a cushion in case of an emergency.

Sadly, Asian powers have done little more than episodic fretting over recurring geopolitical threats to their vital oil supplies in recent years. As major stakeholders in what could be the biggest jolt of instability in the Middle East since the Arab Spring, they should launch a concerted diplomatic push to dissuade Iran from retaliating.

As the Islamic Republic's major oil buyers and trade partners, they have the necessary leverage. It is time they used it.

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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