The oil markets have survived the Iran War sprint. Bousso: Now the marathon.

The expansion of the Mideast conflict to Yemen and the drone attacks on a Saudi oil pipeline are a painful reminder that the Iran War is not a temporary energy shock but rather a long-term, unpredictable test of economic endurance.

The markets are now adjusting to a new, more volatile phase in the conflict. Many of the safeguards which cushioned the initial blow seven months ago, have vanished.

Last week, Donald Trump, the president of the United States, predicted that the conflict will end only when the midterm elections in the U.S. are held on November 3. Midterm elections are scheduled for November 3. The tone has changed dramatically from the initial suggestion by the administration that war would only last a few weeks and not even months.

It is impossible to tell if this new forecast will prove correct, but recent events at two of the most important energy routes in the world suggest that it could be very optimistic.

The Gate of Tears

Houthis, who are allied with Iran in Yemen, have made rapid progress over the last week. They now hold the Bab el-Mandeb Strait near the southern entrance of the Red Sea. The group, which announced a blockade on the shipping route last July, has stated that all ships except those owned by Saudi Arabia are safe to transit.

Saudi authorities reported that a series of attacks by drones launched from Iraq temporarily closed Saudi Arabia's East-West oil pipe, the kingdom's primary alternative to the Strait of Hormuz.

Since the Strait of Hormuz was disrupted by the conflict in February, the 1,200-kilometre (745 mile) pipeline has become critical to the kingdom.

Saudi Arabia offset some of its losses by increasing west coast oil exports to between 4 and 5 million barrels a day (bpd) during the first five month of the conflict. This is equivalent to about 4% to 5% global oil supply.

Kpler?data reports that shipments in August fell to 2 million bpd, the lowest level since January. This was largely due to the Houthi Blockade. The International Energy Agency (IEA) reports that the output of what was once the largest oil exporter in the world fell to 6,000,000 bpd, the lowest in over 30 years, in August.

Satellite images suggest that at least one pumping stations was damaged, but the extent of damage and timeline for repairs are still unclear. Saudi Arabia can also draw from stored crude oil to compensate for any disruption in pipeline flow. This could take several days. This escalation is occurring at a very dangerous time.

Running Dry

The disruption of Middle East oil exports, which made up around a fifth (or more) of the global supply before the war, has dramatically eroded world stocks. According to the IEA, inventories have dropped by 507,000,000 barrels or roughly 2.8million bpd since the war began.

The fact that more crude oil has left Hormuz recently than in the beginning of the war is largely due to more vessels using the route along Oman’s coast, under U.S. Navy surveillance. Kpler estimates that around 5 million barrels per day (bpd) of crude oil and refinery products have been shipped through the Strait since June. This is a quarter less than pre-war levels. However, the actual figure could be higher, as many ships turn off their navigational systems while transiting.

Last week, Iranian attacks on more than a dozen oil tankers trying to transit the Gulf or cross Hormuz were a reminder of how dangerous transits can be.

This status quo cannot continue. Middle East is the largest energy producing region in the entire world. It may be possible to reduce crude oil exports from the Gulf for a couple of months, but not forever.

According to IEA estimations, refineries like diesel, jet fuel, and gasoline have suffered far more than crude oil, with exports remaining 60% below their pre-war level. Diesel in particular has been severely affected, with prices reaching record highs. Saudi Arabian Red Sea exports are also under pressure, which would increase global inventory levels.

The latest flare-up may also lead to a reduction in the ship traffic through Hormuz. The fear of entering conflict zones is still a factor for tanker operators. Insurance and freight costs are at an all-time high, and naval escorts only mitigate the risks to a certain extent.

Different tones

How long can these market dynamics last?

Iran's leadership sees the conflict as an existential threat and is therefore motivated to exert maximum economic pressure both on the U.S. economy and on the global economy before any negotiations.

Washington's "increasingly strict" blockade on Iranian oil exports has caused severe economic damage to the Islamic Republic, increasing the cost of continuing the conflict indefinitely.

Temporarily, the Houthi attacks and advances on Saudi infrastructure could temporarily shift momentum back to Tehran.

These competing pressures may eventually bring both parties to the table for negotiations. They could also encourage both sides to continue fighting, hoping that their bargaining positions will be strengthened by economic or military gains.

Markets assumed that Trump would find a way out of the gridlock once rising gas prices and political costs became too painful. This outcome was dependent on Tehran's?willingness to cooperate. It has so far shown little willingness to do so.

U.S. policymakers, traders and investors may have adapted to a conflict which appears manageable.

If the war continues for several more months as Trump has suggested, there is a risk that the market will be left with fewer shock-absorbing devices.

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(source: Reuters)