THE ECONOMIST: Donald Trump’s options to cool oil prices are limited as world’s oil flow slows to a trickle

On March 9 Donald Trump declared that the third Gulf war, now in its second week, was “pretty well complete”.

With Iran’s military capacity “wiped out”, America’s president averred, Operation Epic Fury would end “very soon”. “If needed”, America would escort vessels through the blocked Strait of Hormuz and offer political-risk insurance to any tanker operating in the Gulf.

To Iran, he issued a new threat: stop holding global energy markets to ransom or Uncle Sam will bomb your power plants and other “important targets”.

Those markets took comfort from the mixed messages. Brent crude, the global benchmark, sank by 8 per cent on March 10, to $91 a barrel. Talk to anyone other than oil traders, though, and nervousness persists, not least because Mr Trump cannot end hostilities alone, even if he was serious about doing so.

The boss of Saudi Aramco, the world’s oil colossus, has warned of “catastrophic consequences” if the war drags on. The International Energy Agency, a club of oil-consuming countries, has already held two meetings this week to discuss emergency measures.

Mr Trump says he has “a plan” to keep energy prices contained. What options are available to him and other world leaders?

The closure of Hormuz is the most sudden shock to global supply in the history of petroleum. Last year some 14m barrels per day of crude, equivalent to 14 per cent of world output, plus another 4m b/d of refined oil products sailed the waterway.

A fraction can be redirected via pipelines in Saudi Arabia and the United Arab Emirates, but that still leaves around 15m b/d of oil and products trapped in the Persian Gulf.

To alleviate a shortage of this magnitude, governments can try three things: increase traffic in Hormuz; release strategic stocks; or boost crude exports from other places. These levers, though helpful, have limits. And all carry risks.

The most immediate fix would be for more tankers to cross the strait. The lack of war-risk coverage seemed like a big problem last week, when many insurers rushed to renegotiate existing policies.

On March 6 America’s International Development Finance Corporation earmarked $20b to insure vessels trying to exit the Gulf, to be renewed when the facility is exhausted. It identified “best-in-class, preferred American insurance partners” to work with shipowners.

One problem with this idea is that American firms may lack expertise in such policies, most of which are underwritten by established institutions in London.

The facility also does not cover oil-pollution liability, needed for tankers to enter most ports.

JPMorgan Chase, a bank, reckons it would require $352b to cover all oil tankers trapped in the Gulf — more than the DFC’s maximum permitted liability under all its programmes combined. Oil traders are pricing in low confidence that America would reimburse all claims.

In any case, war-risk insurance may be less of a problem than Mr Trump makes out. Industry insiders report that policies remain available.

Premiums have risen to 1-2 per cent of the value of ships — a three- to six-fold increase on pre-war levels, says Simon Lockwood of WTW, a broker.

But shipowners can absorb the cost because freight rates from the Gulf to Asia have more than doubled.

Ships are not crossing the Gulf not for want of insurance but because they do not want to get hit by Iran’s indiscriminate attacks.

Military escort could help in principle. Between July 1987 and September 1988, amid war between Iraq and Iran, America reflagged dozens of Kuwaiti tankers and escorted them through Hormuz with the help of more than 30 warships.

Convoys, which departed about once a week on average, typically involved several warships and two or three tankers. In practice, though, one such convoy a week would do little to return to prewar traffic of over 50 oil tankers a day.

At that pace it would take two and a half years to get all 320 or so vessels currently stranded in the Gulf out of there. Even resuming three-quarters of Hormuz sailings would still prevent nearly 4m b/d of oil from getting to global markets. That is far more than analysts feared might be lost when Russia attacked Ukraine in 2022, a shock that sent Brent to $128 a barrel.

To make a real difference, the escort armada would need to be much bigger. But American warships already in the Gulf are involved in the military campaign and reinforcements are weeks away.

Jeff Currie of Carlyle, a private-equity firm, says the cost of a single escort would exceed the value of the cargo it is meant to protect. Any ship attempting to shield tankers would also become a target.

No escort would be fully watertight; Iranian drones have reached well-protected embassies on land. A big oil spill from a single hit could impede traffic for months, notes John Thompson of Ambrey, a maritime-security firm.

A surer way to contain prices is for oil importers to release strategic stocks. Countries have been discussing the option in talks hosted by the IEA, which was founded in 1974 for that purpose after the first Arab oil embargo.

IEA members’ combined emergency stocks number some 1.2b barrels. Governments can requisition another 600m barrels of industry inventory.

All this is enough to cover 140 days of their total net imports. There have been five collective releases since the IEA’s creation, including two in 2022 to counter the shock caused by the war in Ukraine.

Surer does not, however, mean foolproof. Many reserves cannot be drained to the last drop; America’s must keep a minimum 150m-160m barrels — 35-40 per cent of today’s levels — to preserve the stability of the geological caverns that serve as depots.

Releases are also not immediate. In America, once a presidential order of a release is given, contracts must first be awarded; it takes about two weeks for deliveries to begin.

Reserves can be drawn down only gradually, because of pipeline capacity and other constraints. IEA drawdowns have never exceeded 1.3m b/d (in late 2022).

Were all IEA countries to liquidate their strategic stocks at their maximum achievable rate, they could add at most 3m b/d to global supply, calculates Martijn Rats of Morgan Stanley, a bank. And if a country does all this, it could signal that it expects the war to last, encouraging traders to bid prices up — especially if that country is America.

What about alternative suppliers? The fastest way to bring greater volumes to market is to relax secondary sanctions on Russia, the world’s third-largest oil producer.

On March 5 America issued a 30-day waiver allowing India to purchase some of the 140m barrels of Russian crude already at sea, of which one-fifth is already in Indian waters.

This is a relief to Indian refiners, which typically source half their crude from the Gulf. Sumit Ritolia of Kpler, a data firm, reckons India could lift its Russian purchases to 2m b/d, up from about 1m b/d in recent months.

Mr Trump has hinted the waiver will remain in place as long as Hormuz is closed. It may be broadened to cover fresh Russian output and other buyers, too.

The Russian solution also has limits, however (beyond moral ones of propping up Vladimir Putin’s murderous regime). Unable to procure spare parts and expertise because of sanctions, Russia’s ailing energy industry cannot easily raise output.

Any prospective buyers will thus be competing for a limited number of barrels. Before long discounted Russian Urals crude may no longer be much of a bargain.

A less problematic alternative source of supply is America. Its shale producers have the flexibility to crank up output at short notice.

The problem is that these days shale firms focus on returning cash to shareholders rather than drill, baby, drill for its own sake.

With American production near record highs, they will not invest in new wells until they are confident high prices are here to stay. And even then they could add only up to 300,000 b/d over 6-12 months, estimates Jorge León of Rystad Energy, a consultancy.

Short of ending the war, then, the best-case scenario of realistic reserve releases, more Russian crude and a bit more American shale gives just over 4m b/d.

This is less than a third of the Hormuz shortfall and would take weeks to materialise. In the meantime, more Gulf producers will run out of space to store their stranded oil.

Iraq and Kuwait are already shutting in wells; the UAE and Saudi Arabia are reportedly trimming production. Within three weeks combined cuts could approach 10m b/d — roughly 10 per cent of global output.

Even after Hormuz reopens, restoring idled oilfields to full capacity would take between two and six weeks, says a former engineer on a Kuwaiti project. Wood Mackenzie, a consultancy, warns that Brent could hit $150 a barrel if disruptions persist.

As that prospect looms, governments are reaching for the last lever at their disposal — protectionism.

China has already ordered its refiners to suspend exports of diesel and petrol, sending prices for both rocketing in Singapore, Asia’s oil-trading hub. India may follow. So could America. This would leave some countries in Africa, Asia, Europe and Latin America in dire straits.

The world is watching the strait that matters most with bated breath.