Red Sea War impact on oil prices and inflation - Jan 15

[dan_s]

Tankers South by IRINA SLAV
JAN 15

A week ago, Reuters cheerfully reported that tanker traffic through the Red Sea remained largely unaffected by Houthi attacks on ships in the area that began in November in response to Israel’s bombing of Gaza.

That was then. Now, tankers carrying oil and fuel — and LNG — are being rerouted en masse following an exchange of missile strikes between the Houthis and something called the Combined Military Forces.

The name suggests a broad coalition that has been talked about a lot but in fact consists of “both the US and UK navies”, per Bloomberg and simply “the U.S. and the UK”, per Reuters. Said navies apparently warned shippers to steer clear of the Red Sea for a few days and they are heeding the advice. It’s not just tankers, of course. Ships are going south and prices are rising. For everything. So are emissions.

Last week, S&P Global reported that container freight rates for vessels carrying goods to Europe had spiked to the highest in 15 months as the longer journey from Asia to Europe around Africa tightens vessel availability. It might just be the beginning — but not one of a beautiful friendship.

Per the FT, freight rates for a standard container moving from China to Northern Europe have gone up from $1,500 in November to over $4,000 in January. But that’s okay because $4,000 is so much less than the $14,000 per container traders saw during the pandemic. Sure, it could always be worse but how this is any consolation I’ve no idea. And it may well get worse.

"The fear in the oil market is that the region is on an unpredictable escalating path where at some point down the road supply of oil will indeed in the end be lost," Bjarne Schieldrop, a commodity analyst with Swedish bank SEB told Reuters on Friday, for a story that listed several tankers that were redirecting away from the Red Sea.

Also on Friday, Brent crude hit $80 per barrel for a little while before sliding back towards $78. Traders must not be nervous enough yet. Must be all that safe oil supply from the United States that is moving freely across the Atlantic to Europe and is apparently perceived as unlimited. Which, alas, it isn’t.

Yet oil is only part of this latest disaster equation. Since all vessels are abandoning the shortest route between the East and the West, it’s everything that is getting more expensive, including solar panels, by the way.

These higher prices are coming hand in hand with higher emissions due to the longer ship journeys and some companies’ decision to switch from ships to planes. Let’s admit it, life doesn’t get much more ironic than that.

The Financial Times reported on Friday that many logistics companies were opting out of maritime transport at least partially, combining it with air transport for part of the way. Demand for this mixed manner of transportation was 25-30% higher than usual this month, according to one unnamed company.

The result of this increased demand for shipping+air was driving up prices, of course, with 1 kg of cargo getting transported from the Middle East to Europe now costing 35% more than it did a month ago. A dream come true for the eurozone economy, which has been doing so well since 2021 the ECB raised rates ten times in a row.

But all is well because — pay attention — the EU will be sending several frigates to the Red Sea, to provide “defensive cover for merchant shipping”, according to the chairwoman of the defence committee in Germany’s parliament. If you feel compelled to ask “What merchant shipping?” seeing as everyone’s fleeing the Red Sea, please do so. It’s a brilliant joke.

The announcement mentions one German frigate and “other nations' vessels” that remain unnamed, possibly out of shyness or a sense of confidentiality before they spring those frigates on the Houthis and dazzle them with their military might into giving up on shooting at ships. You know, just like the Combined Military Forces did last week. They did so well, now everything in the Red Sea is a target.

The reason I’m being so caustic is that the so-called coalition took a bad situation and made it worse. Suddenly, everyone is talking about an escalation and Biden is telling Iran privately that “we're confident we're well-prepared”. For what, remains unclear but I’m sure the Iranians are trembling in their boots. Because the exchange of threats always works so well and “force is the only language these people understand”.

Sure, that might be the case but the Houthis might just speak that language better than the “coalition”, judging by the latest attack that targeted nothing less than a U.S. destroyer. Much trembling, indeed, plus a warning from a Chatham House analyst:

“The Houthis are far more savvy, prepared and well-equipped than many western commentators realise. Their recklessness, and willingness to escalate in the face of a challenge, is always underrated.” Now why does that sound familiar… Oh, yes, Russia was going to run out of ammunition by April 2022 and lose spectacularly.

But enough about foreign policy ineptitude. Let’s look at what the immediate future holds thanks to the above situation. Shortages is one thing it holds. On Friday, Tesla and Volvo Car said they were cutting production in Europe due to a shortage of components, per a Reuters report.

"The armed conflicts in the Red Sea and the associated shifts in transport routes between Europe and Asia via the Cape of Good Hope are having an impact on production in Gruenheide," Tesla said in a statement, adding that the longer journeys were creating “a gap in supply chains”.

How cruel is that, when those supply chains were just starting to mend after the pandemic lockdowns. And it’s happening only a couple of months after Elon Musk said Tesla would be building a 25,000-euro car at the Gruenheide factory near Berlin.

Another thing that is happening is higher prices for solar panels that I mentioned at the beginning. This came straight from one local solar developer and it came in December. That developer warned that panel prices are going to shoot up because of the ship rerouting and deliveries are going to get delayed. Sadly, just because you know you have a problem doesn’t mean you have any way to solve it.

This is going to spread, too, and engulf the global economy. At least according to economists cited by — and I apologise for this — The Guardian.

“There is a horrible and inevitable progression that could see the situation in the Red Sea spread to the strait of Hormuz and the wider Middle East,” a former OECD chief economist told the daily. John Llewellyn put the risk of a serious global trade disruption from events in the Red Sea at 30%, The Guardian said, up from 10% a week ago.

For some, such as importers of Qatari LNG, the disruption is already a fact. Bloomberg reported earlier today that five LNG tankers that set off from Qatar were halted before reaching the Bab el-Mandeb strait off the Yemeni coast.

Three of these, the report said, citing cargo-tracking data, were idling off the coast of Oman, one was in the Red Sea, and the other was in the Mediterranean, near the Suez Canal. I guess the last one at least might reach its destination before the captain gets old.

All this is good news for American energy producers. Both oil and LNG exports are going to surge further as Europe grapples with the consequences of what is effectively the shut-off of the Red Sea route. So are prices. And, for the third time, so are emissions. I like repeating that because it is so funny.

It is a symphony of disaster and its name is We Have No Good Move. There have been zero attempts from energy import-dependent Europe to apply any sort of diplomatic pressure on Yemen or Iran while their imaginary energy security crumbles once again because of that import dependence. There have only been frigates, for now on paper only.

Now, this could give the powers that be more ammunition for the transition crusade and we will probably hear a loud doubling down on own energy production from wind and solar for better supply security. Yet, as noted above, there’s a cost problem with that. And this problem will likely get worse before it gets better. How long a way will the billions dedicated to the transition go in this new, even-higher-price environment?

I guess we shall have to wait and see, and what we are going to see will not be nice. For now, the advisory sent by the U.S. and UK forces in the Red Sea to shippers is for a few days. I’d call that extremely optimistic unless they have carpet bombing plans, which, unwise as it would be, to put it mildly, cannot be excluded as a possibility.

Yet even maintaining the status quo of tit-for-tat strikes will put a strain on world trade and weigh on economies, even as shippers adjust to longer journeys and higher freight costs. They will adjust, sure, but will buyers? And if there’s an oil supply shock brewing, how hard will it hit?

The FT today cited a Barclays analyst singing the default oil market song about “high levels of spare capacity, slowing demand and robust non-OPEC+ supplies”. It’s a bit like deliberately shutting your eyes to what they tell your brain because you don’t like it.

Spare capacity is spare. It is not going to be put into work unless those holding it decide to — and they are currently cutting their production.

The slowing oil demand refrain is as much wishful thinking as a conclusion drawn on the basis of economic growth projections that may or may not materialise — though they certainly would materialise if oil prices rise.

Finally, the robust non-OPEC supplies are not unlimited, much as they may look this way. Judging by the spending plans of U.S. producers, they are in no rush to flood markets in response to potential supply threats in the Middle East. And why should they? All producers like higher prices for their product — when the product has no viable substitute.
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MY TAKE: The situation in the Middle East will get worse before it gets better. The U.S. will be forced to deal directly with Iran eventually, despite how much the Biden Administration wants to keep gasoline prices low heading into an election because "Iran will fight to the last Houthis!"