Should We Take Iran's Threats Seriously?

Isac Simon, The Motley Fool

It now seems that Iran is trying to blackmail its way through by issuing a second warning threatening the closure of the Strait of Hormuz. Governments and analysts around the world are now considering whether it's just hot air. But there's more than that. While it'd be easy to take sides or pooh-pooh the threat, investors must realize that things can turn out to be a little more complicated. In short, global crude oil prices could see an all-time high.

Details of the doc
The Iranian navy chief stirred up the latest hornet's nest following a 10-day drill in international waters. The latest warning comes two days after Iranian Vice President Mohammad Reza Rahimi mentioned that "if Iran oil is banned, not a single drop of oil will pass through Hormuz Strait." Located between Iran and Oman, the strait connects the Persian Gulf with the Gulf of Oman, and is the only sea link from the Persian Gulf to the deep ocean. Most of the Saudi Arabian oil is shipped out via this strait, making this choke point account for a sixth of the world's oil shipments.

The immediate reaction from analysts across the globe will hinge on whether to take the warnings seriously, However, from an investor's viewpoint, it'd be more prudent to check the possible ramifications this event could have on crude oil prices.

Assuredly, the Fifth Fleet of the U.S. Navy has responded that such a move won't be tolerated. Now, let's say Iran goes ahead with its warnings and a skirmish takes place. Now what?

The fact is that any form of military action is capable of pushing up oil prices substantially. One only needs to look back to the Libyan crisis. At the onset of the revolution, crude prices shot up a sizable 28% on fears of a shortage in global oil supply. This took place despite the fact that the African nation's pre-crisis contribution to global oil production was only 2.2%.

Economics 101
In simple terms, it's just a matter of demand and supply. The global oil balance is hanging delicately. According to the International Energy Agency, for the third quarter of 2011, global oil demand stood at 89.6 million barrels/day while the corresponding supply stood at 88.5 Mmb/d. Even in peaceful times, the facts look a little hard to digest. Again, as Fellow Fool Alex Planes argues cogently, in any case, cheap oil isn't coming back.

That said, I won't be surprised if there's a sharp hike in prices in case of a military conflict. It doesn't really matter who wins. Even if the U.S. forces have the upper hand -- which is the likeliest outcome -- the markets are bound to react wildly. Seventy-five percent of the oil flowing through this channel is on its way to the Asian markets, where demand is steadily growing. The consequences of a disruption in supply would be dangerous.

Mere lip service?
The second factor that needs to be accounted for is the total loss of Iranian crude supply. While the Gulf Arab states have announced that they are ready to offset any shortage induced by a total embargo from Iran, the assurance needs to be taken with a grain of salt. Realistically speaking, that isn't so easy. The question is, how will the Saudis counter the blockage of the Hormuz Strait? There's no easy way out. The desert kingdom can reroute its oil via pipelines, which are again far below the 15 Mmb/d capacity available through the strait. Additionally, infrastructure and transmission costs are bound to go up on a per-unit basis.

Still, at the end of day, I hope I'd be proved wrong.

What's the alternative for investors?
In the meantime, Fools shouldn't leave anything to chance. The U.S. dependence on Middle Eastern oil is expected to decrease with the advent of the shale plays and Canada's Athabasca oil sands. The Bakken shale play has been a revelation this year. Companies like Samson Oil & Gas and Kodiak Oil & Gas are poised to increase production substantially in 2012.

Offshore oil discoveries around the globe are picking up, most notably off the Brazilian coast. Petroleo Brasileiro, along with Chevron, has already started developing the deep-sea resources. Now, SeaDrill has joined the bandwagon, saying it plans to "offer a wider range of oilfield services in Brazil."

Foolish bottom line
I personally believe that plenty of waters will yet flow down the Strait of Hormuz before Iran is likely to make good its threats. Right now it'll be more of a watch-and-wait, while at the same time investing in the right stocks to take advantage of any situation that may arise. What's your take on the latest development? Sound off below.

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At the time thisarticle was published Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Chevron and Petroleo Brasileiro. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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