RIYADH: Oil markets spiked in the immediate aftermath of the conflagration in Yemen. Destined to be short lived, the geopolitical premium already begun fading by Friday afternoon.

Earlier the prices had jumped about 5 per cent on Thursday as markets panicked with the news of airstrikes in Yemen by Saudi Arabia and its allies. Benchmark Brent oil neared the $60 a barrel mark, while the US West Texas Intermediate (WTI) crude soared above $50, approaching 2015 highs.

Air strikes sparked fears of disruption in global crude supplies. Some hinted at the possibility of a spill over into the neighboring countries. In order to avoid any aftershocks, Riyadh announced strengthening not only security at borders but also around oil and industrial facilities. Kuwait too has boosted security around its oil sites.

The markets began panicking despite the fact that Yemen is not a major oil producer, producing just around 130,000 bpd in recent months. Yemen’s strategic location also appeared contributing to the initial market reaction. The passage between Yemen and Djibouti, known as Bab el-Mandeb, are less than 40 kilometers wide, and considered by the US Energy Information Administration (EIA) to be a “chokepoint” for global oil supplies.

It connects oil tankers from the Mediterranean to the Indian Ocean. Crude carrying vessels need to pass through the Yemen coastline via the Gulf of Aden to get to the Suez Canal, a key passageway to Europe.

As per the EIA estimate, some 3.8 million barrels per day of crude passed through Bab el-Mandeb in 2013.

The “closure of the two-mile strait would force tankers to sail around the southern tip of Africa to reach European, North American, and South American markets,” the US Department of Energy says.

If the corridor is blocked, the alternative route via the Cape of Good Hope would raise tanker costs to $150,000 from $45,000.

But is that a real threat in the current set-up? After all, the US Navy routinely patrols the region.

And additionally Egypt has sent naval vessels to help secure the passage. And this is despite the fact that the adversaries – the Houthis – do not exactly have a strong maritime presence.

And any spill over from into neighboring borders also doesn’t seem feasible at this stage. Land forces are not in operation – at least – as yet. And in the meantime, not only the borders have been secured further, there are also hints that allies may also join in to protect the Saudi borders.

Additionally, oil installations of the kingdom are not only fully secured, they are thousands of kilometers away from scene of action too. Any disruption in crude flow, thus at best, remains a farfetched idea at this moment.

It is perhaps in this perspective that analysts think of the current spike to be a short lived phenomenon only, some attributing last week’s rally to short covering after steep losses in early March, underlining the gains to be brief as worries about a supply glut continue to linger in the market.

There’s no need for markets to overreact as Yemen is not a significant player in the oil industry, writes Nick Cunningham. The surge comes amid growing concerns of oil overflowing storage tanks in the US and around the world, which threaten a new round of weakness in oil prices.

And this possibly meant that once the initial shock of the conflict wears off, oil prices will likely pare back their gains, with markets refocusing on weak fundamentals. Crude oil storage at Cushing is three-quarters full. China’s strategic petroleum reserve is nearly full. US refineries are temporarily closing for spring maintenance. All of these things will push the price of oil back down.

“Just because Saudi Arabia and others conducted air strikes doesn’t mean the oil market becomes suddenly tight,” Masak Sumetsu, manager of the energy team at Brokerage Newedge in Tokyo, told Reuters.

There is indeed little rationale for the oil markets to be rattled at this stage. Despite the current spike, normalcy in crude markets is bound to return – sooner rather than later.

Published in Dawn, March 29th, 2015

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