Crude oil extraction

Crude Oil Prices Climb on Red Sea Risk

Jan 4 2024

Crude oil prices climbed in Wednesday’s trading as shipping companies avoided the Red Sea following further attacks on vessels at the weekend and an Iranian warship arriving in the region on Monday. The 3% increase in Brent Crude prices indicate that the balance between weak macroeconomic demand and geopolitical risk seems to be tilting towards the latter as the major market driver at present.

Red Sea Vessels Remain Under Threat

Since late November, numerous ships passing through the Red Sea as part of a journey via the Suez Canal have been subjected to attacks by Houthi rebels. The Yemeni group is supported by Iran and initially stated that the attacks on ships would be restricted to those bound for Israel as part of support for Hamas in the Israel-Gaza war. However, commercial ships with no connection to Israel have since been attacked with increasing regularity. According to the Guardian, “about 12% of global trade passes through the Red Sea, including 30% of global container traffic” which is why the attacks are so concerning for supply chains and commodity markets.

On Sunday, after receiving distress calls from the container ship Maersk Hangzhou, a US Navy helicopter fired on Houthi boats which were attempting to board the container vessel. The US Navy confirmed it had sunk three of four Houthi boats and that none of the crew survived and described its actions as ‘self-defence’. The incident could trigger wider escalation of a conflict which had, until this point, been primarily contained within Gaza. The arrival of the Alborz destroyer, an Iranian warship, into the Red Sea on Monday creates the potential for further clashes. Several US, French and UK military vessels are already in the areas part of the US-led ‘Operation Prosperity Guardian’, a multinational operation intended to protect Red Sea shipping routes.

Given the heightened regional tensions, it is unsurprising that several major shipping companies have directed their vessels away from the region. Danish shipping giant Maersk, owner of the ship attacked on Sunday, announced on Tuesday 2nd January that its ships would avoid the Red Sea for the next 48 hours. German company Hapag-Lloyd, which has also had a ship fall foul of a Houthi attack, has directed its ships away from the Red Sea until January 9th.

The additional journey time required for transporting goods around the Cape of Good Hope, instead of via the Suez Canal, is estimated to be between 10-14 days. Delivery lead times will increase as a result of choosing this safer passage but, perhaps more importantly, shipping companies are also incurring significant additional fuel costs for the longer journeys. However, freight rates have not spiked yet; the graph below shows the Baltic Dry Index within ChAI Insight, which began 2024 trading at the same level at which it finished last year. However, it may not be long before the index ticks higher, which could push ChAI’s forecast for the next month from neutral to bullish. French shipping group CMA CGM announced that its prices for shipping a container between Asia and the West Mediterranean will increase as much as 100% from January 15th, as reported by Reuters.

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Q4 Data Signals Weak Demand

Although the Houthi attacks in the Red Sea have been ongoing since late November, it is only in the past few days that the associated risk appears to have superseded the weak macroeconomic conditions as the key narrative in oil markets. Economic data from the final month of last year has dampened expectations for a stronger global economy this year. Markets will be watching for US PMI data to be published on Wednesday, with expectations that it will be higher than November’s but still below 50. The US data will be under the microscope after S&P Global's PMI survey published on Tuesday showed that the nation’s PMI had declined from 49.4 in November to 47.9 in December.

The pattern of stalling factory activity to close the year was found elsewhere too. China’s official PMI figure showed a contraction in activity for the third consecutive month, although it is worth noting that the Caixin PMI for the same month reported an unexpected increase. India’s PMI was released on Wednesday, and though it stood at 54.9 for December and therefore showed increasing activity, this was nonetheless the lowest the figure has been since June 2022. South Korea, Taiwan, Malaysia and Vietnam all reported contractionary PMI figures for the final month of last year.

A further factor to consider in the context of weaker demand is the February meeting Joint Ministerial Monitoring Committee of OPEC+. These meetings are intended to evaluate the implementation and impact of the groups’ policy decisions on production. Following the cuts announced at the last meeting in late November, and the muted market reaction to those cuts, it is unlikely that global oil production would be significantly reduced before this meeting in February. However, it now seems that the short term risk for oil supply could come from the challenge of transporting it, rather than extracting it.

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