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Bousso: The bet of the oil markets on a short Iran shock will soon be tested.

Investors are betting that disruptions to Middle East oil supplies will be brief. This optimism, however, may not be justified. The third day of conflict has not yet caused any damage to the oilfields in the region, but the inability of fuel to be shipped out of the Gulf has already put a strain on a global energy system that is tightly interconnected. Each day of disruption increases pressure on both producers and consumers, causing bottlenecks in the Middle East for exporters and a worsening of shortages elsewhere. The oil prices rose by more than 10% on Monday, reaching the highest level in a year. They then fell back to $79. This was a reaction to the extensive U.S.-Israeli airstrikes on Iran that took place over the weekend. These strikes killed the Supreme Leader Ali Khamenei, and provoked retaliatory attacks against Israel and Gulf States, plunging this region into the gravest crisis it has experienced in decades. The oil industry was hit hard by the fallout. After at least three vessels were hit, tanker traffic in the Strait of Hormuz - the narrow waterway that connects Iran and Oman and carries 20% of the world's oil - was all but halted.

Although the strait is not officially closed, on Monday, 150 ships were stuck nearby as their operators avoided entering into the Gulf for fear of further attacks or being trapped. Iran has also targeted energy infrastructure and ports in the region. Saudi Aramco on Monday shut its largest domestic refinery, the 550,000-barrel-per-day (bpd) Ras Tanura plant, after a drone strike. Qatar, the second largest producer of LNG in the world, has halted LNG production at its massive Ras?Laffan plant following drone attacks. The news caused European benchmark gas to surge by up to 50%. The global oil market will likely be able to absorb this disruption if it lasts for only a few short days. Global oil supply is abundant due to increased production around the world. Several major consumers such as China and the U.S. could use strategic reserves to temper price spikes and cushion shortages.

The backlog could be overwhelming if the conflict continues.

The Strait of Hormuz is effectively closed and the clock is ticking. Around 15 million barrels per day of crude oil and over 4 million barrels per day of refined products (including gasoline, diesel, and jet fuel) leave the Middle East via the Strait of Hormuz. Once the tankers are full, producers may be forced to divert oil into onshore storage if the war doesn't end soon. The region does have extensive storage facilities but they are only able to accommodate a few days worth of normal exports in the event that flows are blocked.

According to Augustin Prate, an analyst at Kayrros, Saudi Arabia has around 82 millions barrels of crude in its onshore storage. This represents 56% of the country's capacity. The remaining storage space could be filled in 10 days with a production rate of 10 million barrels per day and an export rate of 7 million barrels per day. According to Prate, Kuwait and the United Arab Emirates have respectively 34 million barrels and 28 million, which is equivalent to more than 40% capacity.

Saudi Arabia could ease pressure by diverting its exports via a pipeline capable of carrying around?5million bpd to the Red Sea Port of Yanbu.

The UAE has also built a pipeline that connects it to Fujairah, a storage terminal beyond the Strait of Hormuz.

Both pipelines are in use, so their capacity to transport extra oil is likely limited. The length of the conflict is still unknown. Donald Trump, the U.S. president, said on the weekend that military activities could last for at least four weeks. The Republican President, who has promised to combat the high cost living at home, will 'likely' deploy all available tools, including the U.S. Navy, to keep oil costs in check by securing the shipping lanes.

This effort is not guaranteed to be successful. Even if there are formal assurances in place, insurers and shipowners will likely remain cautious. They may limit flows even with naval escorts.

Long considered the worst-case scenario for the energy industry, the closure of the Strait of Hormuz is now a reality. The more time the Strait of Hormuz remains blocked, the greater the pressure on Middle East producers who may be forced to reduce output if storage is full.

This would then transform what the markets currently treat as a temporary shock, into a much more durable challenge to the global oil system.

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(source: Reuters)