What worries oil traders the most as tensions build in the wake of Iran’s missile attack on Israel is a potential disruption to the flow of crude in the Middle East — and when it comes to Iran, the Kharg Island export terminal could be a key target for the Israel Defense Forces.
“Kharg Island is where Iran loads the majority of its crude exports,” said Matt Smith, head U.S. analyst at Kpler. “That, as a target, would cripple crude exports the most.”
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Contributing to a spike during Thursday’s session was U.S. President Joe Biden’s response, when asked by the press whether he would support Israel striking Iran’s oil facilities, that discussions were being held.
Most of Iran’s crude-oil exports are sent through Kharg Island, which is located in the northeastern part of the Persian Gulf, according to the U.S. Energy Information Administration, and is sometimes referred to as Iran’s “oil island.”
An attack on the oil terminal on Kharg Island would have “the most disruptive effect, with some 90% of Iran’s global exports passing through those terminals,” said Gerard Filitti, senior counsel at the Lawfare Project. If that happens, he said, oil prices can be expected to “immediately spike more than 10 percent and continue increasing.”
Repairs to Kharg, “even under the best circumstances, would take months, and while Iran does have other terminals, the distance and capacity of those terminals cannot replace the output from Kharg,” said Filitti, whose litigation experience extends into the oil and gas industry.
A comprehensive strike on Kharg Island “cannot be understated,” he said. It would be “devastating for the Iranian economy, which is reliant on oil exports for access to U.S. dollars and the global market.”
Overall, Iran’s oil output averaged 2.82 million barrels per day in 2023, according to S&P Global Commodity Insights. The country’s oil fields are estimated to hold 12% of the world’s total oil reserves.
Iranian crude exports have averaged nearly 1.5 million bpd this year — nearly half of its oil production — and the country is looking to boost its oil output capacity to 3.9 million bpd in 2025, up from 3.4 million bpd this year, Smith said.
Smith said Israel’s threat of an attack on Iran’s oil infrastructure is “more of a warning than anything at this point.”
Still, the oil market may already be close to having priced in a scenario in which 1.5 million barrels per day of supply is taken offline by an Israeli strike on Iranian infrastructure, said Simon Lack, co-manager of the Catalyst Energy Infrastructure Fund MLXIX.
Members of the Organization of the Petroleum Exporting Countries could produce another 500,000 bpd or so, while U.S. production could potentially rise by 250,000 bpd, he said. “So I think it’s manageable.”
Read: Oil shock? How OPEC+ could soften the blow if the Middle East conflict hits supply.
Kpler’s Smith, meanwhile, said that if Israel were to target Iran’s oil and gas infrastructure, the Abadan refinery near the border with Iraq could be a possible target. That facility accounts for 17% of Iran’s refining capacity and 13% of its gasoline supply, he said.
“Targeting an oil refinery would hurt Iran in several ways — not only reducing its gasoline supply, but also freeing up crude supply,” said Smith. “Iran already struggles to find buyers for its crude given sanctions. The vast majority heads to China.”
Still, oil traders have rallied oil prices this week as Middle East tensions flare. Iran launched a missile attack on Israel after Israel started military operations in southern Lebanon in its latest offensive against the Iranian-backed militant group Hezbollah.
On Thursday, global benchmark Brent crude’s December contract BRN00 BRNZ24 gained $3.72, or 5%, to settle at $$77.62 a barrel on ICE Futures Europe — up 8.5% for the week. U.S. benchmark West Texas Intermediate crude for November delivery CL.1 CLX24 added $3.61, or nearly 5.2%, to finish at $73.71 a barrel on the New York Mercantile Exchange, up 8.1% for the week.
Tensions between Iran and Israel have have put a damper on benchmark U.S. stock indexes, with the Dow Jones Industrial Average DJIA and S&P 500 SPX on track to end lower on the week, but the S&P 500 Energy sector XX:SP500.10 was poised for a weekly rise of more than 5%.
If Israel strikes Iranian oil-export facilities or refineries, Simon Wong, a research analyst at Gabelli Funds, told MarketWatch that oil prices would like move higher as a “knee-jerk reaction.”
Global benchmark Brent crude prices may increase by $10 to $15 a barrel in reaction to a disruption in oil flow in the Middle East, he said, adding: “What happens subsequently depends on how Iran responds.”
Oil-export facilities aren’t Israel’s only potential targets in Iran, Wong said. Others would include nuclear facilities, refineries and air defense facilities, he said.
The flow of oil through the Strait of Hormuz — a narrow waterway that borders Iran and is the most sensitive transportation chokepoint for global oil supplies — is also a significant concern.
The waterway averaged 21 million barrels per day in oil flow in 2022, representing 21% of global oil consumption, according to the EIA.
“If Iran oil production and exports were disrupted, then other OPEC countries could produce more oil relatively quickly to prevent a prolonged oil shortage,” said Rob Thummel, who manages the Tortoise Energy Infrastructure Total Return Fund TORIX at energy asset manager Tortoise.
“The difficulty is that the likely oil supplier to fill any gap of Iranian shortfalls is Saudi Arabia or Kuwait,” he told MarketWatch. “These barrels would have to be transported through the Strait of Hormuz. If Iran could successfully close or disrupt oil transportation through the Strait of Hormuz, which borders Iran, then the world has a larger problem.”
Thummel said a prolonged disruption, such as a closure of the strait that temporarily reduces global oil supply by 20%, would cause oil prices to “temporarily spike” — potentially over $100 a barrel.
Keep in mind, however, that the U.S. is “keenly aware of the significance of the Strait of Hormuz and is likely to use all means to keep the strait open,” Thummel said.
