The U.S. is currently trying to increase international sanctions on Iran over the country's nuclear program, something that has caused Iran to threaten to close the Strait of Hormuz, the Gulf's oil gateway to the world. This may not have gotten a lot of front-page news in the last week, but it's something everyone should be worried about.
If analysts are correct, the conflict will pass without a conflict because the effect on Iran would be far greater than on the U.S. or its allies. But the impact of sanctions is already being felt, and it may not be affecting the world in the way you would think.
Oil trades higher on fear
There's no surprise that oil has traded higher recently on fears that Iran will retaliate. But the move has been subtle and hardly the kind of spike you might expect if threats were actually going to occur. That's partly because traders don't think the threats are going to lead to action and partly because this kind of geopolitical risk is already baked into the price of oil.
Oil is $100 per barrel for a lot of reasons: traders driving up the price, OPEC keeping production down, and production costs increasing. But more people are starting to realize that there's constantly a price premium because much of the world's oil comes from the most volatile countries. Iran, Nigeria, Iraq, and Syria are just a few of the countries that could explode at any moment disrupting supply. Disruptions would have a ripple effect for many companies.
Troubled waters ahead
If production is interrupted and Iran does block the Strait of Hormuz, the effect on oil tankers could be catastrophic. The biggest shipper Frontline (NYSE: FRO) had to restructure its business recently since it was in so much trouble and business partner Ship Finance International (NYSE: SFL) has had a rough year as well. Ship owners have been hit by increased tanker supply and low rates and a cutback in shipping out of the Middle East could lead to more losses.
China's pickle
China has said it won't join sanctions against Iran, but there are a number of reasons it's in the country's best interest to stay on the sideline. Iran is one of China's biggest oil suppliers, and an extended disruption would be disastrous for the manufacturing powerhouse.
China is also setting up to benefit from sanctions against Iranian oil in an unintended consequence for the United States. Rhodium Group analysts think China will be able to negotiate a 10% to 15% discount for Iranian oil as sanctions tighten. Since the country is Iran's biggest oil buyer, it certainly has an upper hand if its other customers join an embargo.
Sending Europe over the brink
With parts of Europe on the brink of economic disaster, a disruption of oil supplies could send them over the edge. So it shouldn't be a surprise that Europe delayed sanctions for six months to allow Greece, Italy, and Spain to secure new supplies. By then it's likely some sort of resolution (or conflict) will have been reached.
Europe is much more reliant on the Middle East for oil than the U.S., which has been cutting back on the oil for years, so the impact on Europe would be much higher than domestically.
Domestic supplies become a hot-button again
The U.S. is still dependent on others for oil, but most people don't realize that U.S. dependence on foreign oil, the Middle East in particular, has fallen dramatically since 2005. Net imports have fallen from 60.3% of product supplied in 2005 to 45.4% in the first 11 months of 2011. Imports from OPEC have fallen from 30.5% of product supplied in 2008 to less than 25% last year.
With worldwide oil supply relatively constrained, that will put more pressure on domestic oil companies and offshore drillers outside of the Middle East. Statoil (NYSE: STO), Whiting Petroleum, Continental Resources (NYSE: CLR), and Kodiak Oil & Gas (NYSE: KOG) have more than a million combined acres in the Bakken shale play, the fastest-growing oil production play in the U.S. and higher potential prices could mean even more drilling.
Growing production in the Gulf of Mexico, off the Atlantic, and even in Alaska could be keys for U.S. oil production as well if the Iranian fallout spreads. The Obama administration is opening new locations in the Gulf and Alaska for future sales, but rising oil prices or production disruptions in the Middle East could put pressure on the government to speed up the process.
No matter how you look at it, increasing domestic oil production both on and offshore will be critical if this dance with Iran goes on much longer.
An interconnected world
If Iran continues to threaten to close the Strait of Hormuz, we need to be prepared for the realities the energy industry will have to deal with. For investors that means taking another look at domestic producers like Kodiak Oil & Gas, Continental Resources, and Whiting Petroleum, which have onshore assets or Statoil, which has onshore assets and attractive new offshore assets in Africa.
What seems certain for the time being is oil will stay close to $100. Our Rising Star analysts have identified three companies that will benefit from $100 oil and are revealing them in a free report. Click here to access the report before it's gone.
