Iran stand-off could trigger oil price spike

Fears of another oil price spike are climbing as the war of words between the West and Iran intensifies.

By Emma Rowley and Garry White

The worst-case scenario is that the ratcheting tensions will end in a military confrontation that would close the Strait of Hormuz, the strip of water between Iran and Oman that represents the world's most important shipping lane.

Roughly 40pc of the world's seaborne traded oil passes through the waterway, so the suggestion that traffic could be hindered has inevitably lifted the oil price. Brent crude, London's benchmark oil, advanced 5.9pc last week.

The threat has arisen as Iran responds to Western sanctions designed to make it end a nuclear programme said to be aimed at producing an atomic bomb.

New Year's Eve saw Barack Obama, the US President, sign an act banning foreign financial institutions that do business with the Iranian central bank from trading in the US, which has refused Iranian oil since 1979.

Meanwhile, the EU – which takes about a fifth of Iran's oil exports – is close to imposing its own sanctions.

The impact is already being felt, with Iranian citizens queuing up at banks to convert their savings into dollars as their own currency plunges further.

As the sabre-rattling grows louder, Tehran has warned that closing the Strait would be "easier than drinking a glass of water".

Analysts agree it would be fairly simple to disrupt ships' passage through the waters. All Iran would have to do is put a few mines into the Strait and it would be a no-go area until the US Navy cleared the waters.

So how much risk is there that the Strait closes? Many think it is the most unlikely outcome. Iran would take a severe economic hit from the move, as it would not be able to export its own oil or import vital materials.

However, there are worries that politics rather than economics will rule Iran's behaviour and that it could lash out at its opponents.

"At some point sanctions become an act of war," Vali Nasr, a former foreign policy adviser in the Obama administration, has warned.

There is also a risk that the situation could escalate as an unintended consequence of the domestic political backdrop in Iran.

While last year the Arab Spring political uprising represented the major risk to the oil supply, this time around it is the "Iranian Spring election factor", according to Malcolm Graham-Wood, an energy analyst at VSA Capital.

With the Iranian elections due on March 2, industry watchers expect the anti-West rhetoric to ratchet up several notches – and, accordingly, nerves around the oil supply.

Analysts at Barclays Capital explain "that the rising rhetoric on closing the Strait and the new military exercises [by Iran in the area] run the risk of triggering an unintended escalation through miscalculation.

"For example, we cannot rule out the possibility that Iran might start to selectively stop and inspect ships travelling through the Strait, a move that could certainly create a broader crisis."

In terms of the longer-term – and more likely – impact of the row, the risk is not so much the fallout from a possible closure of the Strait so much as the negative impact the sanctions will have on oil production from Iran, as demand for their product suffers. A reduction in capacity again adds to the risks that the oil price will spike.

Since most oil price predictions are based on sluggish global demand as the world economy wobbles, as opposed to geopolitical tensions, analysts see the Iran situation as the single biggest factor that could send the oil price upwards. A higher oil price will, of course, drag on economic growth, as it signals rising costs for businesses and individuals.

So will anyone benefit from the stand-off? Perhaps those oil traders with a cool head, who remember that previous bristling over the Strait, as seen in the 1980s, did not leave the waters closed.

"Only brave hearts would go against the current move with the risk of a short-term spike looming," said Ole S Hansen, senior commodity strategist at Saxo Bank.

"But look out for any news that points towards an easing of the tensions as it could trigger some aggressive selling."