Brief Red Sea Scenario Analysis
Jan. 26, 2024
The tensions in the Middle East have driven up the risk premium on crude prices. There is concern that military clashes between Israel and the Palestinian Islamist group, Hamas, could escalate into a broader regional conflict, with markets worried the conflict could expand and disrupt wider Middle Eastern supply. Given the uncertainty of the situation, we look into a few potential scenarios and discuss changes in tanker demand.
In the scenario where the Red Sea choke point is completely shut down due to continued attacks, our scenario analysis anticipates owners to reroute around the Cape of Good Hope, significantly boosting tanker demand and providing upward support on freight levels. There is one bypass for Saudi to export crude from the Arabian Gulf to Western destinations – by maximizing the use of the East-West Pipeline. According to the US EIA, this pipeline with a total capacity of 5.0 million b/d is currently operating at 2.1 million b/d; the unused capacity is well above the total AG>West crude demand at present. However, increasing the pipeline throughput is projected to put downward pressure on VLCC demand, removing both AG>Red Sea and AG>Suez Canal demand as well as reducing the sailing distance when replacing AG>UKC route with Red Sea>UKC.
In the case of an oil embargo on Israel, we anticipate the US to fill the gap of 180,000 b/d of crude demand from the country. This scenario would increase Aframax demand equivalents from 4 to 17 vessels due to much longer trade distances. In the case of Hormuz Straight disruption, we foresee Saudi and UAE would maximize the use (+3.8 mil b/d) of the East-West Pipeline and Abu Dhabi Crude Oil Pipeline, bypassing the Strait. This could result in a sharp decline for VLCC but boost mid-size tanker demand and higher prices could incentivize heavy inventory drawdowns as well. In the extreme case of a Suez Canal closure, we assume oil flows remain at current levels while sailing distances notably increase though the Cape of Good Hope. This scenario would see most demand for Suezmax & Aframax with 72 and 66 demand equivalents respectively compared to only 4 additional VLCCs. Similarly, for the CPP segments, a Suez Canal closure would result in net vessel demand equivalent additions of +45 LR2s, +17 LR1s, and +30 MR2s.
Given the factors discussed above, we provide the VLCC and LR2 TCE impact based on the various Middle East scenarios. Please note our base case is reflected as the “Status Quo” scenario and the main observation remains that the mid-sized tanker segments will benefit the most from all scenarios, particularly the CPP segment.
For more in-depth analysis of the Middle East turmoil, we invite you to explore our upcoming 2024 – 2028 Tanker Market Outlook, published at the end of January.
Figure 1: VLCC & LR2 TCE Impact
Source: McQuilling Services
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