How the Yemen Crisis Will Affect Oil Prices

Yemen crisis affect oil pricesMilitary action has escalated in the Yemen Saudi conflict as the fighting continues. This has spooked global oil markets, leaving investors wondering how the Yemen crisis will affect oil prices.

Could a country producing 150,000 barrels per day, accounting for less than 0.02% of the global oil output, really have an effect on world oil prices? Yes, it could, but investors should stay focused on the real crisis in oil—U.S. production.

The Yemen Saudi Conflict: How Will the Yemen Crisis Affect Oil Prices?

Abd-Rabbu Mansour Hadi, the current president of Yemen, appealed to neighboring allies to help provide military support. Saudi Arabia and the Gulf Cooperation Council members, including the United Arad Emirates (UAE), Kuwait, and others, carried out air strikes on Thursday, March 26. The Gulf region allies are willing to help Mr. Hadi, as they see the Houthi fighters as an expansion of Iranian power and a catalyst of instability in the region—a region dominated by a Sunni Muslim majority. Iran has denied providing support to the rebels and is seeking an immediate cease in military aggression from the allied force.

It isn’t clear how soon the conflict will be resolved, but Yemen closed seaports last Thursday, leaving many worried of further escalations affecting seaborne oil transportation in the region. According to the U.S. Energy Information Administration (EIA), 63% of global oil production travels via tanker. (Source: United States Energy Information Administration, November 10, 2014.)

Of several energy choke points in the Middle East, the relevant one in this case is the Bab-el-Mandeb strait, located between Yemen and Djibouti (a neighbor of Somalia). The EIA estimates that 3.8 million barrels per day, or nearly four percent of global output, of crude oil flows through the strait that allows the transportation of oil coming from the Persian Gulf to the Suez Canal. (Source: Ibid.)

Closure of the Bab-el-Mandeb would not only restrict oil heading towards Europe, it would also limit southbound flows looking for the most direct route to Asia. However, oil trade is unlikely to be affected by the Yemen crisis. Not only do the Houthi rebels lack maritime capabilities, but the United States Navy has already pledged to aid its Gulf region allies.

The Real Oil Crisis: What’s Actually Affecting Crude Oil Prices

The threat of this conflict spreading to the rest of the Middle East is the primary concern. Contagion fears have spiked once again, reminding many of the Arab Spring and the ensuing crises in Libya, Syria, Egypt, and others. Fear is nevertheless likely to subside as it did on Friday, when Brent crude oil prices declined five percent, erasing the previous day’s gains. From here, the markets are likely to focus on the real crisis in oil—U.S. production.

The problem is that U.S. oil production continues to advance. On a global scale non-OPEC (Organization of the Petroleum Exporting Countries) production accounts for 61% of oil produced globally. The U.S., which produces more crude oil than Saudi Arabia, accounts for nearly 10% of the world’s crude oil output. (Source: International Energy Agency, March 13, 2015.)

The U.S. is clearly a major oil player and despite falling drilling rig counts and cuts in capital spending for 2015, the oil keeps flowing. Data provided by Baker Hughes shows that rotary rig counts have fallen by 45% since last year. Analysts estimate that they can drop another 15% as in past oil downturns. (Source: Baker Hughes, March 27, 2015.)

Despite falling rig counts, U.S. crude oil stocks continue to pile up, while crude oil prices remain weak. Crude oil inventories are up 22% year-over-year and are still growing. (Source: United States Energy Information Administration, March 20, 2015.)

According to the International Energy Agency, for 2015, global demand is projected to hit 93.5 mb/d (million barrels per day), while the current global supply stands at 94 mb/d. That excess supply represents the supply glut on which the market is focused. The situation in the North American market is worse, due to unprecedented U.S. shale oil production.

The latest numbers (February 2015 output) show that the U.S. has grown its output by 23% since 2013 and seven percent since 2014. Production is expected to grow by another nine percent in 2015, adding more barrels to an already flooded market. (Source: International Energy Agency, March 13, 2015.)

While the short-term focus will remain on the Yemen crisis, we may see wild swings. I suggest investors pay attention to the situation closer to home—oil production out of major U.S. basins like the Bakken, which produces eight percent of U.S. crude oil and natural gas liquids and is expected to increase production by 20% in 2015.

Understand this: Basic economics are at play here. If the supply continues to increase, it will not be surprising to see world oil prices remain at their current levels or decline, unless there’s a huge influx in demand—which is questionable as the global economy is showing signs of severe stress.