BEN HARVEY: Why a swift end to US-Iran war won’t bring price relief

The lumbering goliath of the world’s oil market is a type of very large crude carrier which goes by the thoroughly unimaginative name of Very Large Crude Carrier.

A VLCC is one of the most stupendously enormous things on earth. Its cavernous cargo holds can accommodate about 2 million barrels of oil.

Two million barrels of oil is a stupendously enormous amount of liquid. One barrel is 42 American gallons.

Why that amount? Because in the mid-19th century the oil men of Pennsylvania needed a common size for trade and they settled on a vessel known as a wine tierce (pronounced terse).

They opted for these whiskey barrel-shaped containers for two reasons. First, a tierce was a known quantity — they had been around since the 15th century, having been favoured by members of the British royalty, who were prone to visiting a glass of vino.

Second, once filled with oil a tierce weighed about 300 pounds, or 130kg. They were heavy but two strong men could wrestle one onto a railway carriage for transport.

As big as a VLCC is, each ship carries a tiny fraction of the world’s daily oil needs.

We consume about 104 million barrels every 24 hours. No wonder Greta Thunberg is always so grouchy.

The Iran war has meant a great many VLCCs are sitting idle, either trapped in the Persian Gulf with full loads of oil, or waiting, empty, on the south side of the Strait of Hormuz.

The oil market is particularly sensitive to this kind of disruption because there is very little fat in the system.

It costs a bomb to store the stuff, so we operate what is known as a just-in-time production schedule. This methodology was perfected in the 1930s by the founder of the Toyota Motor Corporation.

Kiichiro Toyoda (no, I don’t know why his name has a D and his company has a T) worked out he could maximise profits by making just enough cars, at just the right time.

A just-in-time system keeps prices low, but the quid pro quo (as motorists have discovered over the past few weeks) is a fragile supply chain.

The only place on earth with any decent oil storage capacity is the Middle East and much of that infrastructure is either blown up or locked up.

Respected Australian energy analyst Saul Kavonic reckons the glitch in the oil matrix means the world is short by up to 5 million barrels of oil a day.

One barrel of oil, you will recall, is 42 gallons. Speaking metric, that’s 159 litres.

That’s a 795 million litre deficit. Every day.

We are short 320 Olympic swimming pools of oil. Every day.

Sorry, Greta.

Saul thinks the two-week ceasefire (which is one foam Nerf Gun pellet from collapsing) isn’t the end, or even the beginning of the end.

He hopes (as Winston Churchill did after the Battle of Britain) that the ceasefire is the end of the beginning, but warns that whatever the actual “end” date is, we’re in a world of hurt at the fuel bowser for a very long time.

It will take years for producers to make inroads into that 5 million barrel-a-day shortfall and for the period that buyers outnumber sellers, prices will stay elevated.

Unfortunately, the law of supply and demand isn’t the only thing that will keep the cost of fuel higher for longer.

Kavonic pointed out this week that Iran has worked out it can hold the world to ransom by throttling the Strait of Hormuz or destroying a few of those lumbering VLCCs.

The executives that sit astride the mysterious web of underwriters and re-insurers that make up Lloyd’s of London are acutely aware that Tehran could flex its muscle more frequently in the future.

Lloyd’s of London insures many of the VLCCs we rely on to keep the juice flowing. Each one of the ships costs about $US140 million.

Imagine what the insurance premiums are going to be in coming years.

The market will price in that heightened risk into every oil-related transaction for years to come and the ubiquitousness of oil means that’s pretty much every transaction.