Oil exports through the Strait of Hormuz might not return to levels seen before the Iran war

The oil market might face a new reality after the Iran war in which exports through the Strait of Hormuz do not return to the levels once considered normal, as shipowners now have to weigh the risk that fighting could abruptly break out in the volatile Persian Gulf.

And Western commercial ships will likely hesitate to sail through Hormuz if it remains under Iran's de facto control, especially if they have to coordinate with the Revolutionary Guard, putting them at risk of violating U.S. sanctions.

It is a scenario with consequences that are difficult to foresee given the vital role that Hormuz plays in global energy markets. Freedom of navigation through the strait was never seriously challenged until Iran basically closed the sea lane in response to the war launched by the U.S. and Israel on Feb. 28.

Iran's blockade of Hormuz has triggered the largest oil supply disruption in history, putting pressure on the U.S. to make a deal as the threat to the global economy grows by the day. Tehran appears intent to use this leverage to consolidate control over the strait in a settlement that ends the war.

Middle East leaders believe that Iran has already taken control of Hormuz, said Amos Hochstein, who served as a senior energy and national security advisor to former President Joe Biden.

"No matter what happens, the Iranians will control the Strait of Hormuz for the foreseeable future," Hochstein told CNBC's "Squawk Box" on Thursday. "It doesn't even matter what the deal says. Everybody in the region believes that."

Oil tanker traffic through Hormuz before the war might represent the high point for transits for the foreseeable future, said Helima Croft, head of global commodity strategy at RBC Capital Markets.

"Any end to the conflict that leaves Iran exercising operational control and influence over the Strait will result in appreciably lower flows through the waterway in our view," Croft told clients in a Thursday note.

Traffic under this scenario might return to 60% to 70% of prewar volumes with China-affiliated ships moving freely while passage for Western vessels require bilateral agreements with Iran, said Richard Meade, editor-in-chief of Lloyd's List, in a briefing on May 21.

"This doesn't trigger a recession in the way that some of the doomsday scenarios that we've talked about before might suggest, but it does not allow the prewar rebound," Meade said. Lloyd's List is one of the oldest shipping industry trade journals in the world.

"It produces something more insidious," Meade continued. "A permanently bifurcated strait where access is a function of political alignment, not freedom of navigation."

The Red Sea crisis

The crisis that throttled ship traffic through the Red Sea shows how geopolitical instability can disrupt trade chokepoints for much longer than originally expected.

Houthi militants in Yemen that are allied with Iran started attacking commercial ships in November 2023 in response to Israel's war in Gaza. The attacks began on Nov. 19 with the hijacking of a cargo ship and continued with missile and drone attacks for two years.

Daily traffic through the Bab el-Mandeb Strait, which connects the Red Sea to the Gulf of Aden, collapsed by more than half from 75 ships on Nov. 19, 2023 to 31 vessels by January 30, 2024. More than two years later, traffic through the strait still has not returned to the levels once considered normal.

One of the major lessons from the Red Sea crisis is that "you don't need a massive navy in order to create major disruption in a maritime chokepoint," said Tomer Raanan, a maritime risk analyst at Lloyd's List.

The Houthis have not attacked a vessel in the Red Sea since the end of last year but that has not been enough for ship traffic to return to levels seen in 2023, said Jack Kennedy, head of Middle East country risk at S&P Global Market Intelligence.

It is uncertain whether the collapse in traffic through Hormuz will last as long as the disruption in the Red Sea. Shipowners will have to decide whether they believe a U.S.-Iran deal, if one is actually cemented, provides sufficient security gaurantees for commercial vessels.

The current ceasefire is likely to hold for now as the Trump administration seems to be prioritizing increased access for commercial ships through Hormuz, Kennedy said.

Even if Iran agreed to open Hormuz without any conditions on transit, it would likely take a long time to return to prewar levels of traffic, Kennedy said. There will be safety concerns, for example, about mines that may have been laid in the strait, he said.

And there is a severe risk that the war could resume over the next year unless a permanent resolution is found to Iran's nuclear and ballistic missile programs, Kennedy said. These are the key issues, particulary from an Israeli national security perspective, that led up to the war, the analyst said.

The ship operators will have to weigh whether they are willing to risk their vessels and assets being trapped on one side of Hormuz for months if war does erupt again, Kennedy said.

Few Hormuz alternatives

But the Red Sea is also different in key ways to Hormuz, said Raanan and Kennedy. One reason Red Sea traffic remains depressed is because ships can bypass it and avoid the security risk altogether by sailing around the Cape of Good Hope in South Africa. Hormuz, by contrast, is truly a chokepoint without any equivalent alternatives, the analysts said.

Hormuz is also much more important to global energy markets than the Red Sea, they said. About 20% of the world's oil and liquefied natural gas supplies passed through Hormuz before the war.

Saudi Arabia and the United Arab Emirates are using pipelines to divert millions of barrels of oil per day from the Persian Gulf to export terminals on the Red Sea and Gulf of Oman. These pipelines have eased the supply disruption but they do not fully compensate for Hormuz.

"You can get some stuff out of pipelines, but not everything can go through a pipeline," Raanan said. "We're not just talking oil that needs to come out of Hormuz."

The whole point of LNG as a product, for example, is it can be loaded onto ships and transported around the world. Hormuz is also crucial for fertilizer and other commodities. In the absence of alternatives, shippers may have to accept and adapt to conditions in Hormuz in ways they did not in the Red Sea.

Still, Middle East exporters are looking for more alternatives. The UAE, for example, is accelerating the construction of a second pipeline that bypasses Hormuz. It is scheduled to become operational in 2027.

U.S. Energy Secretary Chris Wright believes the importance of Hormuz to the global energy market will decline after war, as Gulf nations like the UAE build more pipelines to avoid it.

"This is a card you can play once," Wright said of Iran's blockade. "There'll be other routes for energy to get out of the Persian Gulf."

"We will see a decreasing importance from the Strait of Hormuz, but not a decreasing importance of those nations' energy production and energy supply," he said.