Yemen Strife Reminds Oil Markets That Mayhem Matters

Oil markets got a brusque reminder that geopolitical risk is alive and well Thursday when crude prices spiked in response to military actions by Saudi Arabia and other Arab states to contain the violence in civil-war wracked Yemen.

Prices in New York and London leaped as much as 6 percent in the morning on concerns about the potential spread of the conflict, as well as knock-on effects for oil production in Yemen and Saudi Arabia and oil transport through important global chokepoints like Bab el-Mandeb, by the Gulf of Aden. Oil prices slipped a bit by midday, but were still up a few percent in both trading hubs, keeping Brent close to $60 a barrel.

“Attention is turning back to geopolitics,” said Richard Mallinson, an analyst at Energy Aspects, a consultancy in England. “There are definitely a lot of sources of potential concern for the market in terms of supply disruption.”

The Saudi military involvement in Yemen, including airstrikes targeting Houthi rebels in the capital city of Sanaa and in other parts of the country is meant to shore up the embattled regime of current president Abed Rabbo Mansour Hadi, who fled to Oman by boat on Wednesday. The Saudis have wrangled together a coalition of other Gulf States as well as Egypt and Jordan to fight back against the Iran-backed Shia rebels that have steadily gained control of Yemen in recent months.

The sharp escalation of the Yemeni conflict — and the market’s reaction Thursday — underscores the area’s importance to oil production and trade. Yemen is a minor oil producer, while Saudi Arabia is the world’s largest. And Bab el-Mandeb, the narrow body of water between Yemen and Djibouti, is one of the world’s key oil-transit chokepoints, moving almost 4 million barrels of oil per day. Neighbors such as Saudi Arabia and Egypt have been worried for months that Houthi control of Yemen could put maritime traffic in the crucial strait in the crosshairs. Recently, former Yemeni military officials said Houthis seek to control the strait and its valuable traffic, even though Houthi spokesmen disavow any intention to disrupt the region’s energy trade.

What’s remarkable is not the market jitters on Thursday, but rather the almost complete absence of geopolitical risk as a factor for oil traders over the past year despite a host of reasons for furrowed brows. In years past, bombings in Beirut or saber rattling in important bottlenecks like the Strait of Hormuz would send oil prices jumping. That hasn’t been the case lately — despite plenty of things to worry about in the energy world.

Russia and the West have been in an increasingly tense standoff over Ukraine for more than a year. The Israeli-Palestinian peace process has unraveled. Iran’s oil exports have been squeezed by Western sanctions, and future crude production may be hard to ensure after years of neglect. The Islamic State has rampaged through Iraq and Syria, even as Baghdad is still at odds with the restive northern Kurds who control much of the country’s oil. Syria itself is still in the midst of a horrific civil war. Militias and terror groups have dismembered Libya and targeted its oil sector. Yemen has been disintegrating for months, if not years. Nigeria, another big oil producer, has been wracked by Islamist terrorism in the north as well as oil theft in the southern part of the country. Terror groups have become increasingly brazen in Tunisia and other parts of North Africa. The conflict in Sudan and South Sudan kneecapped oil production there. Further afield, Venezuela totters eternally on the brink of complete meltdown, with questions about how it will keep its own dysfunctional oil sector going.

But all that was happening against the backdrop of a well-supplied, and at times over-supplied, oil market. When there’s excess oil sloshing about, the prospect of losing a few hundred thousand barrels a day of production doesn’t scare anyone. Oil prices, in fact, slipped more than 50 percent since the summer. But as supply decreases, demand rebounds and the oil market tightens, it starts, like a tautened string, to become more sensitive to just these kinds of geopolitical vibrations.

“It’s only when you start to think we haven’t got such a big oversupply, that’s when geopolitical disruptions become relevant again,” Mallinson said. He said it will likely become more important in the second half of the year, as global oil demand recovers even as production trails off, thanks to decreased investment by oil companies.

Saudi Arabia’s worries over Yemen are understandable given Saudi oil production is centered in oft-restive Shia regions in the eastern part of the country. Riyadh has massed troops and heavy artillery along its border with Yemen even though there doesn’t appear to be any immediate risk of spillover from Yemen into Saudi territory.

Egypt’s concern focuses less on the land than the sea: Cairo dispatched four warships through the Suez Canal to the Gulf of Aden to try to secure Bab el-Mandeb. Egypt has to protect traffic through the Suez Canal and the Indian Ocean approaches because the canal is worth about $5 billion per year in revenues to Cairo today. And Egyptian president Abdel Fattah el-Sisi hopes to massively expand the canal even more with an $8 billion plan to widen the shipping lane and transform it into an industrial and logistical hub making up about one-third of the entire Egyptian economy.

That makes the security of the entire area a priority for Egypt, not just Yemen’s immediate neighbors. And it underscores the degree to which, in a gradually tightening oil market, messy political and military realities will again elbow their way into the energy world.

Photo credit: MOHAMMED HUWAIS/AFP/Getty