From Hormuz to Asia: the ripple effects on oil trade, prices and economies

View Full Transcript

Sambit Mohanty:

Hello and welcome to Platts Oil Markets Podcast, a series by S&P Global Energy. The conflict in the Middle East has sent ripples across the global energy landscape with the spotlight on the Strait of Hormuz, the critical artery for Asia Pacific's energy imports. In the middle of trade flow disruptions, the paths to recovery, the resilience of physical oil markets, and broader economic consequences are under intense scrutiny. While the return to normalcy, the evolving dynamics of oil storage, the transmission of supply shocks to Asian economies, and the policy responses shaping the region's future energy strategy are some of the key themes that are dominating the discussions, the market is also looking for answers on transparency and pricing, benchmark adjustments, and market adaption during turbulent times.

I'm Sambit Mohanty, Asia Energy Editor and your host for today. To discuss some of the key themes, I'm pleased to welcome Atul Arya, Chief Energy Strategist at S&P Global Energy, Dan Colover, Global Head of Oil and Chemical Markets Engagement, and Vishrut Rana, Asia Pacific Senior Economist at S&P Global Ratings. Welcome all. Although let me address the first question to you. There has been a lot of talk about disruptions and damage from the Iran conflict, but let's focus on the potential paths to return to normalcy when it happens. You have rightly pointed out in some of your recent discussions that even modest reductions in effective transit capacity can have non-linear effects under capacity constrained conditions, clearing a backlog becomes a sequencing problem, not just a flow problem. And as your vessels move first, condition shifts downstream, and non-priority segments absorb the delay.

This distinctions is even more critical for downstream markets. As a result, physical supplies will be shaped not by whether Hormuz is open, but by how quickly barrels can exit, how long they will take to arrive, and which regions have the least buffer. With Asia dependent on flows to the Strait of Hormuz, if you can sum up your views on the path to recovery of state flows to the region.

Atul Arya:

Thank you, Sambit. Great to be back on your podcast. I think we should start by saying that historically when we see energy shocks, supply shocks are always much more challenging to deal with than demand shocks. So we had a demand shock during COVID, but that really was a big shock economically, but for the energy markets, they managed it. The supply shock we have today is very difficult to manage. And another challenge, as you already alluded to, Sambit, is that this shock is primarily being felt by the economies in Asia, even the large economies, as well as the growing emerging markets in Asia. To address your question about how do we get back to some degree of normalcy, just a few quick numbers, rough speaking. About 100 million barrels of crude oil and products per week is currently not getting into market, which would normally flow from the Middle East into Asia, 100 million barrels.

So if you take cumulatively, given we are, I think in 9, 10 weeks of the conflict, we are looking at close to a billion barrels. To get that back into the market will take a long time. And also we cannot really restart the fields right away because, as you also said, there is issues around storage and across the storage, the crude and products in storage will have to flow and then the fuel production will start. So we are looking at several months. It really depends upon when the strait opens and when it opens, what is the flow? Before the conflict, there were several hundred ships flowing every day through the strait in both directions. Will that ramp up quickly or will that be a slow ramp up? What are the security arrangements? So this impact is going to take a long time to unwind.

The other thing which we are seeing now based on our data, S&P data, Sambit, is that the ships, or the VLCCs in particular, those who are normally going into the strait and into Middle East are moving away and they're looking for other cargoes. And some of them coming from the Americas, particularly North America, there is some excess capacity, some in production, some in storage. So getting the VLCCs back into the region will also take time. So this is going to be a big logistical nightmare which will have to be unwound, but also production and refining systems will all have to line up. This is not going to be easy to solve.

Sambit Mohanty:

Yeah, and just still don't know when exactly, how quickly things going to bounce back, whether there'll be ceasefire or not. Too many questions there. Atul, I'll stay with you for the next question also. The physical oil market remains tight and you have mentioned a little bit. In early April, we saw commercial oil stocks dropping by about 6.5 million barrels. Importing countries are likely to continue to tap into the strategic reserves while China continues to draw additional stocks. Do you see this will lead to the heart of growth of floating storage and also if Middle Eastern exporters may be forced to reduce output due to vessel shortages?

Atul Arya:

Yeah, I think we are already seeing that, Sambit. We have had many countries, at least not only stop shipping, which they cannot, but also stop producing. Kuwait is one of the recent countries to declare force majeure, because their storage capacity is full, so they have to shut down the fields. So keep this in mind that when the fields have to be restarted, it will take time. It's not as easy as just turning the tap back on. It's a more complicated process. In terms of the stocks, besides China, I think Japan is in good position. Japan has several months, I think close to nine months of storage for their own consumption. Also, they're part of the IEA, so that also helps. But other countries, I think where the challenge is the largest, focusing on Asia is, in the poorer countries. And also even a country like India, which has some storage primarily in their refineries, not in the true storage, they're also going to start to feel the impact. But we have seen rationing in other countries like in Philippines and so on.

So I think this is a big issue and the exporters will continue to reduce their output if the situation goes on and the importers will continue to reduce their consumption. I mean, we are looking at significant demand destruction, and going back to a previous question, there may be a situation where there is some permanent demand destruction. People change their livelihoods, the patterns, or they use other fuels. So this could be a very big and prolonged shock to the global energy system, particularly in Asia.

Sambit Mohanty:

Sure. Thanks, Atul. Vishrut, let me come to you for the next question. Let's talk a little bit about the economic implications. The Middle East supplies about 40% of Asia-Pacific energy's imports, and about 90% of the crude oil shipped through the Strait of Hormuz is destined for Asia. However, the region's import patterns vary widely, making overall picture a bit more complex than it appears. While many economies rely on imported crude and refined fuels, some depend on surprisingly small number of suppliers leaving them more vulnerable to disruption. If you can elaborate on some of the channels of transmission of this shock to Asian economy.

Vishrut Rana:

Yeah, thanks, Sambit, and just picking up from the discussion earlier, indeed, we do see significant reliance on imported crude and imported fuels in Asia, and that does have economic implications. The key risk from our perspective is of supply disruptions or rationing of fuel for end users. This has direct implication because it directly curtails economic activity. Stuff that would have happened, people going from place A to place B, or goods going from place A to place B, they just don't go and that is a direct reduction in economic activity. We see that to some extent, but for the moment it has been relatively limited outside of specific cases. I think Atul mentioned the Philippines, but outside of that, we don't see rationing just as yet. Of course, that remains as the key risk on our radar, as you guys have been discussing. The shock is definitely not over yet.

But aside from that, there are transmission issues that happen from the higher energy prices, and the four key channels that we're looking out for, first of all, current accounts. So the higher energy prices lead current account deficits, particularly for the oil importing economies. Next, we look at producer prices. Third, we look at consumer prices. Those two I want to talk about a little bit more because first of all, in APAC, what we see is that producer prices' input costs rise, and this squeezes margins from manufacturers, it leads to output reduction, and that is not easily transmitted onto consumer prices. Eventually, though it does feed through, but the impact is a little bit slower. And finally, the fourth factor that we look at is fiscal. A lot of governments stepping in to support end users, and that means that fiscal costs are going to escalate.

Sambit Mohanty:

Sure. Thank you, Vishrut. Some of the economic points you touched upon, but I'll still ask you a more detailed question around some of the issues about energy prices. High energy prices are driving inflation while also constraining growth and current account balances, as I've pointed out. Across Asia Pacific currencies are weakening as capital flows out of the region, and that is except for mainland China. This is creating a negative feedback loop. Weaker currencies are making energy imports more expensive, which further increases costs and intensifies pressure. Asian policymakers have been very active to shelter consumers from the sharp increase in energy prices. We have seen subsidies, tax cuts, and domestic market prioritization have emerged as key tools, but this will have fiscal implication. What are your views on how Asian governments and central banks are responding to the crisis?

Vishrut Rana:

Yeah, no, certainly, you put your finger on the problem, which is that there is this compound effect of strange rates and the costs of this shock feeding through to the economy, and governments in Asia have generally been active in terms of stepping in and trying to mitigate the impact for end users. We have seen fuel price caps in economies that have not had caps in a long time. I'm thinking of South Korea, Japan, for example, that have stepped in to keep these fuel prices constrained. We've seen various types of measures. So across the emerging markets, the most common ones are subsidized pass-through for end fuel prices, but we've seen deductions in excise duties, export restrictions. All of these are adding up and they're in place almost across the board in Asia. So certainly a lot of action there. The fiscal costs are adding up. It's not likely to be sustainable over a longer run. So the longer this shock goes on, I expect some of these measures are going to be eased a little bit.

Sambit Mohanty:

Sure. That's well put together, Vishrut. Dan, I'll move to you for the next couple of questions and we'll talk about a bigger issue, and this is issue of price transparency during turbulent times. You are based in the Middle East and you watch Middle Eastern prices and oil trade flows very closely all the time. As the conflict began, Platts, as a benchmark provider, made some changes to the Dubai benchmark to reflect the evolving Middle East crude landscape with the aim to maintain liquidity and transparency and ensure that benchmark remains relevant for global pricing and hedging. The implications obviously are wide-ranging, affecting contracts, trading strategies, as well as trade flows. If you can explain the changes and the underlying reasons for that, and also after the changes, how it affect the deliverable volumes.

Dan Colover:

Thanks, Sambit. Yeah, thanks for the opportunity to speak today. So yes, that's correct, that on the 2nd of March, once we saw the conflict taking place, we suspended the nomination of the crude grades that load inside the Strait of Hormuz for Platts Dubai crude benchmark. So what that meant is that we said we will continue to publish all our Middle East crude assessments, including cash Dubai, the benchmark. But what we noted is that sellers may not nominate either Dubai or Upper Zakum or Al Shaheen or Murban, which loads from Jebel Dhanna, upon the convergence of Platts Dubai crude partials during the Platts market on closed process. So what this means is that in a normal pre-conflict scenario, sellers have the optionality of declaring Dubai, Upper Zakum, Al Shaheen, Murban, loading from either Jebel Dhanna or Fujairah or Oman upon the convergence of 20 partials from a single counterparty, and those partials are 25,000 barrels.

So essentially, if a buyer buys 20 partial park cargoes of 25,000 barrels, that forms a physical cargo of half million barrels, and the seller has the optionality of which grade they can declare. So what we said from March the 2nd with immediate effect was that the only two grades that could be nominated upon convergence are Murban loading from Fujairah only, because Fujairah is outside the Strait of Hormuz, and Oman, which loads from Mina' al Fahal in Oman, and those are the only two grades that could be declared upon the convergence. So we removed essentially the seller's optionality of those other grades, Dubai, Upper Zakum, Al Shaheen, and Murban loading from Jebel Dhanna.

This is a decision that we took, methodology changed that we made. It remains a fair amount of liquidity in the benchmark. Oman loads around 800,000 to a million barrels from its load board of Mina' al Fahal, and in Fujairah sees around 1.5 million barrels a day of loadings of Murban crude oil. So that's what we did at the start of March, it's something that has been remained the case as we've heard that this oil that has been trapped inside the Strait of Hormuz has not emptied the international oil markets, particularly Asia in any great volume since the start of the conflict. There remains that shortfall in barrels, but that is sort of the reality of the market right now.

Sambit Mohanty:

Sure. A lot of those grades come into Asia, so obviously there's a lot of interest in this region on how the benchmark evolves and what is the feedback that we are getting. I'm sure Platts has consulted the market on some of the scenarios around the future of Platts Dubai. How has been the response so far?

Dan Colover:

Yeah, thanks for that. So yes, certainly. So once we made that initial methodology change, we sought feedback and we continue to seek feedback on our crude methodology amid the evolving Strait of Hormuz situation, essentially. So we've asked the market how they see things and how ultimately around the resumption of vessel traffic and how that could then impact the implementation of any methodology change that we would have to take to address the scenario. So essentially the bringing back of those grades inside the Strait of Hormuz as grades that can be nominated upon the convergence. And what we've spelled out really is to the market, what would they consider a sufficient volume of traffic and an appropriate timeline for demonstrating non-restricted vessel transit through the Strait of Hormuz? And ultimately, how would that then be able to demonstrate that we should then resume the nomination for the crude or cargoes loading from those ports that require the transit through the strait into the Platts market on closed assessment process.

And we're gathering feedback around that. And we've had a range of feedback from industry participants. So some have said that you would need, for example, 90% of pre-March vessel traffic sustained for one month minimum to demonstrate normalized flows. But not only that, they also mentioned that you would also need a normalization of insurance and freight costs and operational costs, for example. Other people have had a little bit lower, maybe a minimum of 75 to 80% of the pre-war three month average flow of crude tankers via the Strait of Hormuz, sustained for at least one month. And then people have also said that there should only be a considered Strait of Hormuz open when there is a genuine free flow of all vessels regardless of ownership or affiliation. And that would be demonstrated by tracking and widely held market opinion.

And I think ultimately what this is saying is things are not going to go back to how they were before the conflict. Ultimately that ship has sailed, pardon the pun, but I think what the market is looking for is a level of certainty and consistency around the loadings as and when they do resume so that that would be evidenced and then Platts would be able to make an informed decision and share that decision with the market.

Sambit Mohanty:

Sure. Thanks, Dan, for that detailed explanation. We have touched upon the trade flow angle, we have touched upon the economic angle, and then you have nicely explained the pricing angle. And for the last question of the podcast, Atul, addressed to you, CERAWeek took place when the Iran conflict was on. You interacted with a lot of CEOs and policymakers, and some of them were from Asia. I'm sure a lot of key points emerge, particularly for Asia. We saw an LPG crisis in India, since the country's heavily depend on Middle Eastern supplies. Strategic oil reserves in some Asian countries are nowhere close to the levels prescribed by IEA, which you pointed out during your first answer. Run rates have been cut by many refiners and energy rationing in full flow. If you can sum of your views on the energy strategy that Asia needs to pursue in the future to be better prepared for supply shocks.

Atul Arya:

Yeah, and Sambit, actually, Dan and Vishrut already touched on some of these, this shock is going to have very long-term implications. And I think the biggest implication we are seeing, and when CERAWeek happened, the conflict was in the early days. The world is now rethinking what it means to be secure in energy. The new definitions of energy security are emerging, because energy security was having reserves, having good connections to the global market if you were an importer, but all of those assumptions have been turned upside down because there was good connection with the Middle East, but that has not held. So I think what is particularly for the Asian countries and particularly for those countries who are highly dependent on either one or more types of energy, let's say for oil, crude oil products, and also LNG, there's a lot of rethinking happening.

And what we heard at CERAWeek since then, Sambit, there are a number of different angles which are going to be pursued. One is of course that any energy which is local or domestic is the most secure energy. So I think we are already seeing the impact of that, and we heard about that in Houston, that, for example, renewables, which may require imported hardware, but once you have them installed, there is no fuel risk. So that will be a big focus. Coal, which is abundant in many large consumers of energy in Asia, in China, India, Indonesia, others, that is going to be a big part of the equation going forward. Coal will come back. That's what also we heard. Actually, even in the US, we are seeing coal to come back. So looking at domestic energy, that's number one.

Number two is looking at different routes to getting access to the energy. So the world has known about the Strait of Hormuz as a choke point forever, but not much has been done. I mean, Saudi Arabia put in the East-West pipeline, very strategic. I think we're going to see more of that kind of alternatives. And the one thing we are seeing already and was discussed at CERAWeek was will we see revival or acceleration of new resources, for example, gas and oil, gas in particular from other parts of Africa, East and West Africa there's plenty of gas. And also revival of domestic exploration, even in places like India and Southeast Asia, we are seeing that drive to revive domestic exploration. So that is going to be the second big thing.

And the third thing which we have already touched on is the issue of strategic reserves. Every country has talked about the major consumers are building reserves, but not everybody has acted on it. So I think that's going to become a big focus for countries such as India where, as you referred, they did not even have an LPG reserve. So I think that's going to become a big focus. And if countries such as India joined the IEA, that would be one of the requirements as a member, to have full strategic reserves. So I think this focus on reserves is going to become ... In the short term, that's the fix one can have. Growing production, creating alternative routes, particularly physical routes are longer term challenges and longer term actions. But energy security is going to be front and center for a very long time to come.

Sambit Mohanty:

Great. Those were extremely valuable insights. Thanks, Atul, Dan, and Vishrut for joining me in this conversation. The Iran conflict has underscored Asia's vulnerability to supply shocks and the need for robust strategies to ensure energy security. From the logistical complexities of clearing backlogs and managing storage to the fiscal and monetary responses by the government, the region's resilience is being tested. Changes to key benchmarks like Platts Dubai reflect the necessity for transparent and robust pricing mechanisms. As Asia looks ahead, strengthening strategic reserves, diversifying supply sources, and enhancing policy coordination will be vital to weather future disruptions and secure sustainable energy flows. This podcast is produced by Asia Digital Editor Chandreyee Mukherjee, based in Gurgaon. Thank you for listening.