June 21, 2017 9:00 am JST
Vandana Hari

Qatar crisis: Oil supply vulnerability in time of plenty

Crude oil ignores latest Middle East conflict but can't shrug off the risk

The diplomatic rift that opened without much warning between gas-rich OPEC member Qatar and some of its prominent Arab neighbors on June 5 -- then quickly escalated into a full-blown embargo with the severance of land, sea and air links between the countries -- was a reminder that geopolitical risk is an ever-present shadow over the world's energy supplies.

Not that we needed a reminder. Every day, headlines testify to the tensions simmering just below the surface across the Middle East, a region that satisfies over a quarter of the world's oil demand, with cargoes sailing through its vital shipping lanes and vulnerable "choke points" like the Strait of Hormuz. This is not the first time that Qatar has been diplomatically isolated by its Gulf Cooperation Council peers. Saudi Arabia, the UAE and Bahrain in March 2014 recalled their ambassadors from Doha, accusing it of meddling in their domestic affairs.

The coordinated action against Qatar, spearheaded by Saudi Arabia, Egypt, the United Arab Emirates and Bahrain, was ostensibly aimed at forcing Doha to cease its alleged sponsoring of regional Islamist and terrorist organizations. Qatar admits support for some Islamist movements but denies links with terrorism.

This is not the first time Qatar has been diplomatically isolated by its Gulf Cooperation Council peers. Saudi Arabia, the UAE and Bahrain in March 2014 recalled their ambassadors from Doha for, they said, meddling in their domestic affairs. Blockades were threatened but not implemented, and after a diplomatic rapprochement, relations returned to normal by that November. The actions and rhetoric this time are much stronger.

Meanwhile, a quick polarization of alliances in the region -- Iran, Turkey and Russia are aligning themselves with Qatar -- has turned a move against a single state into a locking of horns between two evenly matched blocs. GCC members Kuwait and Oman, which did not join the action against Qatar, have been trying to mediate a peaceful solution, but the problem could get much worse or remain in a stalemate before it gets better.

In theory, that should make the oil markets nervous and inject a "geopolitical premium" into crude prices -- essentially the value of the risk that hostilities could spiral out of control, endanger the flow of crude and refined product supplies from the region, and cause shortages in global markets.

Crude futures spiked briefly in the early hours of June 5, shortly after news of the diplomatic crisis broke, but swiftly resumed their tumble amid a snowballing bearish sentiment tracking other fundamentals, chief among them growing oil inventories in the U.S. and the rest of the OECD world.

Bears have come to dominate the oil market over the past several weeks, primarily on fears that the draining of the global supply glut could be painfully slower than originally anticipated, despite the 1.74 million barrels per day of collective production cuts being implemented by OPEC and non-OPEC producers. The pessimism is fueled by rebounding U.S. crude production, led by the shale sector.

Reports of unexpected and sizable builds in U.S. commercial crude and gasoline inventories -- coupled with a sudden plunge in the country's gasoline consumption despite it being peak driving season -- conspired to pummel benchmark Brent crude to $48.15 per barrel at the close of the first week of the Qatar crisis, nearly 16% below its year-to-date peak settle of $57.10, on Jan. 6.

In fact, so bleak was the mood in the market, that barely had crude's knee-jerk rally on the Qatar conflict collapsed, that prices succumbed to downward pressure on concerns that Doha might decide to walk away from the OPEC cuts, prompting the organization's entire output restraint agreement to unravel.

That possibility was remote and did not materialize. Nor did Qatar shut off its vital piped natural gas supplies to the UAE, which could have ignited the situation. So far, miraculously, all the parties involved have held back just enough to keep the situation from spiraling out of control.

Qatar is a relatively minor crude producer, among OPEC's smallest four, with an average output of around 620,000 barrels per day. But it is the world's largest liquefied natural gas exporter. It shipped about 77.2 million tons of the supercooled gas in 2016, nearly 30% of the globally traded volume, according to the International Gas Union. While its LNG shipments faced some initial hiccups after the crisis erupted, and Qatari ships were barred from refueling at the major UAE bunkering port of Fujairah, overall exports have remained unaffected.

Qatari energy minister Mohammed bin Saleh al-Sada reiterated on June 11 that his country remains committed to its pledged output reduction under the OPEC agreement. Al-Sada was OPEC president in 2016 and led the long-drawn-out and intricate diplomatic efforts alongside Saudi Arabia and Russia to forge a plan to curb output, which culminated in the historic OPEC and non-OPEC deals late last year.

It has been pointed out that the Arab neighbors' conflict with Qatar is not a sectarian one but more about regional dominance, even though Doha has close economic ties with Shia Iran, a rival of Sunni Saudi Arabia. But with Russia, Turkey and Iran jumping into the fight, the tensions now span a wider region, one that already has more than its fair share of political, religious and economic struggles.

Arguably, that improves the odds in favor of the involved parties striving for a diplomatic solution rather than aggression, and thus keeping at bay the tail risk that oil flows out of the Middle East might be crimped. In any case, an oil market that is currently unable to see beyond the big wall of surplus barrels will treat the Qatar crisis as a sideshow. What it can never lose sight of, though, is that as long as oil greases the world economy, the numerous fault lines in the Middle East could deliver a supply shock any time. If that happens, even the rising U.S. shale star of Permian will not be able to come to the rescue.

Vandana Hari is founder of Vanda Insights, which provides research and analysis on the energy markets.

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