If middle east oil flows were seriously disrupted, the multibillion dollar costs and geopolitical impacts would hit New Zealand harder than most other OECD countries. Yet we are less prepared though we have excellent options for local renewable fuel supplies
By Simon Terry
How much would it cost New Zealand if oil’s biggest transport artery, the Strait of Hormuz, was closed for an extended period?
The short answer is billions of dollars, and it could well be double digit billions depending on how things played out.
In other words, escalating tensions in the middle east could ultimately deliver costs in the same league as a major earthquake or a pandemic.
In an extended crisis, the costs could be much more than just higher fuel prices. They could also come in the form of painful fuel shortages and the country potentially trading away significant chunks of sovereignty and economic independence to get fuel.
New Zealand’s particular circumstances mean an extended fuel disruption would cost it a good deal more proportionately than most other OECD nations.
Yet very little attention has been paid to such scenarios in government thinking – even when the country has good options for insulating against them.
Though current preparedness is down around the ankles, there are still options to quickly add some resilience if orders are placed for crisis busting gear before anything hits.
Prelude to War in the Gulf?
Situated at the mouth of the Persian Gulf, the Strait of Hormuz sees around 20% of the worlds’ oil production flow through it.
Iran has for decades threatened to close it if sufficiently provoked.
US President Biden sent a minor shockwave through oil markets at the beginning of October when he let slip that Israel had discussed with him the possibility of it striking Iran’s oil production facilities.
However, by 14 October the Washington Post was reporting that “Israeli Prime Minister Benjamin Netanyahu has told the Biden administration he is willing to strike military rather than oil or nuclear facilities in Iran”. And its subsequent limited response on 26 October was in line with that.
But this does not mean the threat has gone away. Geopolitical analysts have warned for years that if conflict in the middle east escalates, the ultimate risk is an all-out war between Iran and some combination of Saudi Arabia and/or Israel. And the stand back picture to date is a pattern of escalating tensions.
If they do reach a point of all-out war, not only is passage through the Strait at risk, so is oil production in other Gulf states as Iran could counter attack oil facilities in Saudi Arabia and countries aligned with it – taking out up to 20% of global production another way.
Iran explicitly raised this in the second week of October, warning Saudi Arabia that “it could not guarantee the safety of the Gulf kingdom’s oil facilities if Israel were given any assistance in carrying out an attack”, a senior Iranian official told Reuters. Iran even specified that if other countries allowed use of their airspace, this was sufficient grounds for it to attack.
Iran is already operating under strict international trade sanctions and its (sanction busting) oil exports are its main source of income. If in the country’s oil facilities are disabled at some point, the conditions for Iran to then attack other oil producers and/or close the Strait of Hormuz are brought a great deal closer.
Would Iran attack other states? Would it simply close the Strait? Would the US intervene? How well could the US combat Iran’s drones and other asymmetric weapons? Would it be enough to satisfy maritime insurers whose willingness to provide cover is essential to any form of regular tanker traffic in the Strait? How long would it take to repair damaged oil production facilities in an active war zone?
Part of the purpose of this article is to stimulate more consideration in New Zealand of such questions and how to respond to any conclusions drawn. But for now it’s enough to say that what they speak to is the degree of risk – the probability that this event will occur.
The focus here is the scale of damage that could unfold if the Strait closes and/or a sizable proportion of Gulf state oil production is taken out for an extended period.
The Big Jump in Price
The immediate impact would be a big jump in oil prices, with most analysis cautiously projecting an increase from around $US73 a barrel today to “sustainably north of $100 a barrel”.
But others such as Bjarne Schieldrop, chief commodities analyst at Swedish bank SEB, argue the increase would be much sharper.
“If worst came to worst and the Strait of Hormuz was closed for a month or more, then Brent crude would likely spike to USD 350/b, the world economy would crater and the oil price would fall back to below USD 200/b again over some time” he said.
That translates to an increase of 379% initially, and 174% over time. Or perhaps a 37% increase if the price went no higher than US$100 a barrel.
Even just a 37% rise over six months would result in a $2 billion impact on the New Zealand economy, according to an NZIER study.
If it was the 174% rise instead, this does not directly translate to a five-fold increase in damage to the economy. But it’s not hard to see how a figure in the double digit billions could arise.
Yet that’s only half the story. For it assumes New Zealand could still get all the fuel it needs on the market – at a price.
Reality could be different – and more costly still.
Of the 20 million barrels per day of crude and refined products that pass through the Strait, a minority can feasibly be diverted by pipeline to ports beyond the Persian Gulf. But as the sources of that production are also threatened with attack, the same amount of oil is still ultimately at risk and consideration needs to work from this maximum exposure.
That 20 million barrels a day at risk amounts to a 20% haircut on global oil production (of roughly 100 million barrels a day).
The conventional wisdom is that the world has enough stocks of oil to ensure that current levels of use would still be met during the time needed to fix the problem. And that will be true for a crisis that disrupts serious volumes but does not run for very long.
However, if a major crisis runs too long, the rules of the game would change. At that point, geopolitical interests would come to the fore and these rather than price would tend to dominate who gets the scarce supplies.
So the conventional wisdom would come unstuck if a fix cannot be found quickly enough. And the use of Iranian drones to target tankers in the Strait could cause that sort of problem.
Even low tech Ukrainian drone boats have managed to sink or disable a third of the Russian Black Sea fleet and force the remainder out of combat range. Iran has been building increasingly powerful aerial drones and all they need to do to be effective is scare off tanker owners or their insurers over an extended period – without being successfully countered.
Under these conditions, a 20% cut in global oil supplies would not translate to a 20% cut for all nations – far from it.
First in line are the oil producers themselves. Regional data offers an approximate read on their production and consumption balances and also embodies a rough proxy for how small producers will tend to support their immediate neighbours in a crisis.
On this basis, consumption by oil producers and small near neighbours accounts for close to half global demand – say 50 million barrels a day in round numbers. Take that together with the production lost in the war zone and up to 70 million barrels a day is accounted for prior to figuring how to supply the other half of global demand.
It would translate to a 40% haircut for the other half, if shared equally. Except that’s just the beginning of the tussle.
The Big Carve Up
Next comes allocation by oil exporters to their favoured allies/clients. For the two major oil producing regions left standing, Russia and North America, the priorities for their production surpluses are abundantly clear.
Russia would focus its 9 m barrels a day more tightly on its allies and leverage additional support for its Ukraine war in turn. This would likely lead to more of its exports going to a China that is quite dependent on middle east crude – and less to India.
The US and Canada would similarly direct all of North America’s production surplus to their closest allies and partners. This currently amounts to around 9 million barrels a day – with the US contributing similar amounts to Canada.
By now, those gathered around the Cabinet table in Wellington would be looking at the rapidly dwindling available production and seeing that under this scenario, were the US and Canada to meet even three quarters of the consumption of their closest allies, there would be nothing left for New Zealand from North America. While New Zealand may well be in contention for some sort of assistance, it cannot presume a place on that first list of production allocations.
As to fuel from the remaining sources, New Zealand would be up against the likes of an India looking to meet a demand of 5.5 m barrels a day, and China still seeking more after working out what extra it can get from Russia to meet its 13.5 m barrels a day of net imports. Each of which could exert considerably more leverage in negotiations than New Zealand as a result of the types of exports they could control in exchange.
There would be less of a squeeze on remaining oil supplies if the crisis was not a worst case scenario – say only 13 m barrels a day was lost through a closure of the Strait (the amount that could still be trapped after all pipeline diversion options were used), and no oil production infrastructure was harmed outside of Iran.
But because New Zealand would continue to find itself so far down the queue, a less severe event like this would still pose much the same problem in any crisis that is measured in months rather than weeks.
New Zealand’s particular circumstances mean the length of the crisis is the key determinant of what it would face, and though it would seem to have friends enough to ensure it is not totally exposed, it is still badly exposed to an extended crisis.
Oil Stocks and Their Limits
While European nations that have a similar lack of domestic oil production keep about three months’ supply on hand, New Zealand holds around three weeks of fuel in the country at any one time. It’s a perilously thin ‘just in time’ inventory that happens to suit the fuel wholesalers but does not begin to represent adequate fuel security.
There is however a second layer of stocks that in many cases will be available. It consists of another two weeks’ worth of fuel already “on water” and sailing for New Zealand, plus reserves the government has contracted to hold that are stored in other counties and amounted to another five weeks of supply when reported in 2020.
The first of those stocks would be pretty sure to arrive in the county under this scenario. The second is contingently available, and would make it here providing: the contracts hold up in the heat of the crisis, the host government does not ban their export, and the significant amount that is not held in the right fuel forms can be swapped out.
There is a lot to unpack in connection with this offshore storage but for now, assuming all went well with its delivery, the country could be fine through the first 12 weeks – and a useful period longer with prudent rationing and conservation measures.
But after that and well before 24 weeks, with an extended closure of the Strait, the picture is very different when relying on just these stocks.
It’s at this point global fuel stocks come into play, and so the International Energy Agency (IEA).
The key requirement of its mostly OECD member nations is that each holds minimum stocks of fuel equivalent to 90 days of their country’s oil imports.
While many IEA countries may be less import dependent than New Zealand (100%), they would still be exposed to the same proportionate loss of imports. But the effects of a drop in imports lasting more than 90 days would be felt disproportionately by nation’s such as New Zealand.
So would IEA members cooperate to make the economic impacts on member countries more equal in such circumstances? We don’t have a good guide to this from the IEA’s limited history of action. But we do know that the politics would be at least as intense as those surrounding access to Covid vaccines in 2021.
That case also saw a queue of countries that could pay – while the quantity available was capped (by what Pfizer and others could produce in time). And there was a UN agreement especially designed to facilitate equitable distribution of vaccines globally.
What played out instead was a demonstration of raw politics, as the most powerful countries took the early slots for vaccine deliveries, and the less powerful took their places down the queue – as even willingness to pay more was not going to alter the queue place. National interests were to the fore, with even the EU threatening to block exports to the UK of vaccines being made in France for a UK company.
The 101 lesson for any country that is heavily dependent on fuel imports and lacks international muscle is not to rely on equitable distribution of global stocks to save the day.
Scrambling to Keep the Basics Running
For this crisis, New Zealand would need to have planned a number of years in advance to seriously protect against it. However, there are still important things that can be done at this late hour – more on that in a moment.
To cut to the chase, we will fast forward through the anxiety gripping a population that is wondering how to keep households and businesses functioning, the tensions over how much emergency rationing and fuel conservation is appropriate, electric bus fleets becoming heroes of the hour, and the desperate hording activities – to go straight to how this particular crisis would be likely to unfold structurally.
If it runs for a long time, once into the crisis proper New Zealand could face a bleak period with an economy choked by severe fuel supply constraints, and the government continually scrambling to find enough fuel to keep something basic going.
How basic depends on a myriad of factors, including to what degree higher oil prices dampen global demand and allow more side-deals around the basic carve up of global supply that was initially forged by power dynamics.
An indication of what degree of impact could unfold is that level four lockdown was associated with a reduction in diesel use of at least 50% and cost the economy $230 million a day – resulting in a 29% drop in GDP.
A wild card in the pack is how the owner of the world’s biggest fuel reserve would respond and whether it would offer a way to significantly mitigate the damage, by paying a different sort of price.
After the countries with greater economic power than New Zealand, with closer alliance ties, with strategic materials, or with important military capabilities have been attended to, someone from the US State Department might finally call to discuss a deal.
For not only does the US now produce a lot more oil than it consumes (courtesy of shale fracking), it also maintains a huge Strategic Petroleum Reserve (SPR). This is a rarity as countries that are oil exporters tend not to carry serious stocks. But deep in salt caverns along the Gulf coast, the US has a current holding of 381 million barrels in reserve.
Established back in the days when the US imported millions of barrels a day from the middle east, that reserve would not be needed to protect the US in a supply crisis today. In such a case, its strategic purpose would turn to rescuing nations it was willing to assist, … on certain terms.
In New Zealand’s case, it’s safe to say that if you had concerns about the framework recently set by the Pacific free trade deal, the CPTPP, you ain’t seen nothing yet.
Discussions would start from what Japan has already offered up to the US beyond the CPTTP and move on from there.
So what starts off as a fuel pricing crisis, quickly escalates to a fuel supply crisis, that can morph to a sovereignty crisis.
It would then become fully apparent that failing to pay for adequate fuel security “insurance” may blow back as more than just the pain of going short on fuel: it could also result in giving away a sizeable chunk of the country’s remaining economic independence.
But it would first depend on how badly middle east production was disrupted. For while the SPR could meet all New Zealand’s needs for three months from just 3% of its holdings (13 million barrels), the US may have higher priorities.
If it did have fuel from somewhere that it was willing to trade, just how far the US could press into New Zealand’s sovereignty and independence would then depend on how bad things were for the country at the time. But it would be a one sided negotiation if the situation was desperate.
Avoiding having to face the prospect of a one sided negotiation is part of why most countries have been serious about fuel security since the 1970s. New Zealand, despite being more exposedthan most, is far less prepared than most.
A Resilience Plan
Australia is the example the previous government used for comparison when defending its approach of “let the market decide” – on fuel storage and whether it was worth even just encouraging the country’s only refinery at Marsden Point not to close.
Yet when Australia reviewed its fuel security position in 2019, the report’s opening paragraph dismissed the idea that Australia’s similar reliance on the market was a reasonable approach.
“Australia is an outlier in the global community in the way we think about liquid fuel security. When we consider countries of similar economies, most see fuel security as part of their strategic capability and take steps to manage fuel security with that in mind. Australia, by comparison, has chosen to apply minimal regulation or government intervention.”
The title of the Lowy Institute’s commentary summed up the resulting position as: When the tank’s empty: Australia’s impoverished energy security.
While things across the Tasman have not advanced too much in structural terms since the review, Australia at least has sufficient oil production to allow about a 20% net self-sufficiency in fuels – while New Zealand’s useable flow from Taranaki is much smaller and falling.
Its government also acted to ensure Australia’s two remaining refineries would not be taken down – when the New Zealand government stood idle as Marsden Point closed and then let the plant be made inoperable for any future emergency use without due assessment.
Further, Australia got a good head start on the end game that would confront it the same as New Zealand in the above scenario. In 2020, it signed a deal to “lease space in the U.S. Strategic Petroleum Reserve (SPR) to store and access Australian owned oil”. Cheap storage with the not so incidental benefit of making it easier to do side-deals with the US in times of trouble.
This country has finally begun waking from its slumbers, thanks to New Zealand First making work on fuel security a priority for its coalition agreement.
As a first step, consultants have been hired to prepare a review that is due early next year. The ultimate goal is a fuel security plan “to safeguard our transport and logistics systems and emergency services from any international or domestic disruption”.
The Sustainability Council has been proposing a Resilience Plan for Transport Services that is framed by looking at all the fuel options – especially electricity and emergency biofuel production – along with petroleum imports and stocks.
The plan would set out how a targeted level of resilience can be delivered at the least cost over different periods of time. This also needs to be integrated with the Emissions Reduction Plan.
That’s the big picture – the framework to assemble and fill in over time.
But an immediate focus is needed on how to keep essential services running through any fuels crisis.
For the biggest costs would come from losing the ability to sustain the mobility required to deliver emergency services, lifeline utilities, and essential goods such as food and medicines.
And we can act on this right away. We can match that highest value demand with the lowest cost options for quickly boosting security.
A first example is fully electric versions of the heavy trucks that are the backbone of logistics operations. Once landed in the country, these are immediately displacing diesel and adding resilience to the delivery of essential goods.
Models like the Volvo FH Electric offer a 44 tonne rig that can drive for up to 300 kilometres before needing to recharge in as little as 2.5 hours.
While electric trucks are around double the price of a diesel one to buy, because their ‘fuel’ cost is about a fifth the conventional equivalent, they are already close to being commercially competitive.
The government could get them rapidly adopted simply by offering soft finance – comparatively little money for the gain in fuel security.
For vehicles not used as frequently, or where electric versions are not readily available, another option is setting up for emergency biofuel production.
Rapeseed oil can be processed into “drop in diesel”, such that no engine modification is required.
However, it is also a valued food product and would be comparatively expensive to use as an everyday fuel.
One way to make this work is to foster production of rapeseed oil for sale as a food product in normal times, but have the ability to divert it for further processing to biodiesel if there is a fuel crisis.
While the economics of this option remain to be fully evaluated, if attractive the government could contract farmers and processors to deliver specific volumes of rapeseed, and biodiesel when required, while making up the difference between market prices.
Both of these examples deliver ‘perpetual capacity’, and so the ability to keep essential services running indefinitely – even under the most pressing scenarios.
A Priority Action Package
What is needed now is timely decision making to draw such options together into a Priority Action Package of measures that can be quickly implemented to boost resilience for essential services.
Critical to its implementation is getting orders in for the vehicles and equipment that would make this possible.
There is only a limited supply of such crisis busting gear available at any time and if orders are not placed before a supply disruption occurs, then once again New Zealand would be taking its place down the queue.
Better to order now and sell the gear on if a better option comes along than potentially miss out if others sense rising risk and act first.
Why the markets for oil are not already reflecting more risk in their prices is something a number of oil analysts are asking quite pointedly.
If the nature of the global response to oil shortages is not linear, and if the dynamics change radically at the point it looks like there will be an extended crisis over a large volume, then there is more risk than is currently being priced.
And if New Zealand is disproportionately exposed to an extended crisis, then the risk to it in particular is greater still.
Even rather small odds on an extended crisis can produce costs that merit some pretty careful consideration.
For example, were there a risk identified that could cost the country $10 billion and it was thought to have a one in forty years recurrence rate, then in theory it would be worth paying an insurer $250 million a year to cover it.
What that means more practically is that it would be economic to spend something in that vicinity each year on measures that would make New Zealand more independent of fuel imports.
The country has not given nearly enough attention to this sort of response despite the degree of risk we are running.
The Government’s fuel security reviews since 2005 have taken the same single and narrow scenario when looking at international supply disruption – one that does not result in meaningful shortages of fuel, and so provides too weak a test.
Its Ministry of Business Innovation and Employment’s is running out of time to play catchup on many years of reliance on a conventional wisdom that was born in jurisdictions with quite different circumstances, and failing to look at how we would fare if that came unstuck or did not apply the same for New Zealand, and how other quite different international scenarios could leave the country badly exposed.
For unlike the covid crisis, where border quarantine offered a workaround to a low place in the vaccine queue, forget the cheap workarounds if we get caught way down the oil supply queue.
Simon Terry is the Sustainability Council’s Executive Director
This article first appeared in Newsroom on 5 November 2024 and can be accessed here.
