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Strait of Hormuz: How Far Will Iran Go?

Despite what action the Islamic Republic takes, the supply of oil is on the increase in a number of other countries.

The specter of an Iranian closure of the Persian Gulf is keeping petroleum prices near historic high, but the supply picture is better than the gloomy headlines.

“It’s always a question of the perception driving the prices, and the reality does not always drive the perception,” says Michael Lynch, president of Winchester, Mass.–based Strategic Energy and Economic Research.

Michael Wittner, head of oil research at French bank Société Générale, says that while the possibility of an Iranian closure of the Strait of Hormuz is generating huge headlines, he thinks it is a classic low-probability and a very high-impact event. “They would hurt themselves more than they would hurt anyone else.”

One of the sources of Iran’s displeasure appears to be waning: A European threat to embargo Iranian oil is unraveling as countries such as Greece, which are heavily dependent on supplies from Tehran, insisted that existing oil supply contracts be excluded from any boycott.

It may be fanciful, but the Iranian threats to close the strait boosted prices just when they had started to sag. While there is no evidence that Tehran acted to drive up prices, the effect of their action was just that. In fact, analysts say there are several good reasons why oil should be lower than the current $113 a barrel for Brent crude, the international benchmark, and $102 a barrel for WTI, the U.S. benchmark.

Oil supplies are actually increasing nicely, especially from states that do not belong to the Organization of Petroleum Exporting Countries. In addition, Europe’s economy is forecast to have zero growth this year, which could put a global damper on economic activity, thus reducing demand for oil supplies in such places as China.

According to oil industry analysts, oil production is actually on the increase in a number of countries:

Libya: A producer of the highest quality light sweet crude, Libya is forecast to return to its full production of 1.6 million barrels a day in the next few months. It has already bounced back to more than 1 million barrels a day and “just continues to outpace everyone’s expectations,” says Wittner.

Brazil: Brazil has begun to exploit the oil deposits in the so-called pre-salt fields offshore, where the oil lies under 2,000 meters of rock. Analysts expect Brazil’s output to rise between 100,000 and 150,000 barrels a day.

United States: U.S. shale deposits, a relatively new area for oil exploitation, are producing an extra 200,000 to 300,000 barrels a day. In addition, some deep water areas off the U.S. coast are also coming online.

Iraq: Despite reports of terrorist attacks after the U.S. military withdrawal, Iraqi oil output is likely to add 300,000 barrels a day, bringing its total output to about 3 million barrels a day. There are still some problems with pipelines from the Kurdish areas, but they are expected to be resolved in a short time.

Canada: Canadian oil sands are expected to add another 100,000 to 150,000 barrels a day.

According to analysts, the sum total of all this development is likely to add about 1.8 million barrels a day of new petroleum production on a global basis. That’s an increase of about 2.2 percent of the current global output of 90 million barrels a day.

“If you take Iran out of the equation, then actually non-OPEC supply growth equals roughly the same as global demand growth, meaning OPEC wouldn’t have to do much,” Wittner says.

In fact, Société Générale is forecasting that Europe will have a moderate recession this year, which could put downward pressure on oil prices. This recession will likely impact oil demand in China, which currently is Europe’s biggest provider of exports. It could also prompt a slowdown in the U.S. economy, further scaling back demand for oil.

“It’s not that hard to come up with a much more pessimistic economic outlook, and Europe could easily be the trigger for that,” Wittner says.

Nonetheless, Wittner says he is currently forecasting Brent crude at $110 a barrel for the entire year.

Before the Iranian threats, Lynch was predicting a $15 to $20 drop in prices. But the situation in the Persian Gulf is so sensitive that it has affected the oil price going forward, even if the Iranians take no further action.

“Prices are more divorced from market fundamentals than they were six months ago,” Lynch says.

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