Recent incidents in the Strait of Hormuz are prompting increased operational costs for traders, who are apprehensive about what is in store for the region. Sanne Wass reports.
10 minutes. That’s supposedly how close the US was to carrying out an air strike on Iran on June 20 before President Donald Trump had a last-minute change of heart and recalled the mission.
The US president said his military was “cocked and loaded” to strike three different Iranian sites, but balked due to potential casualties. It was meant to be a retaliatory attack after Iran had shot down a US surveillance drone over the Strait of Hormuz, accusing the Americans of violating Iranian airspace.
The incidents illustrate just how tense the US-Iran relationship has become over recent months. And the impact has become very real for the international traders that carry an average of 21 million barrels of oil through the Strait of Hormuz, the passage between the Persian Gulf and the Gulf of Oman, every day.
The destruction of the US drone follows two separate incidents in May and June where tankers were sabotaged by limpet mines while passing through the waterway, with crews forced to abandon their vessels and at least one ship set on fire. The US and its allies accused Iran of being the culprit and responded by sending more troops to the Gulf.
Shortly after, on July 19, Iranian forces seized a UK-flagged oil tanker in the Gulf, saying it was in breach of regulations. And on September 18, after attacks set two major Saudi Arabian oil facilities ablaze, Trump’s administration again pinned the blame on Tehran.
These escalating tensions have led risk analysts to raise their alarm bells for the region, particularly for companies working within oil and gas.
Oxford Analytica’s latest Value at Political Risk report, for example, estimates the oil and gas industry as being the most politically exposed sector globally in Q3, up from fifth place in Q2, due to spiking political violence in the Middle East.
“Oil companies that have got cargo going in and out of the Strait of Hormuz and the plenty of major international corporations that have headquarters in the region, they are concerned about what could happen, particularly the alarming prospect of a war breaking out, which is something we get asked about on a frequent basis. Clearly their operations are at real risk of being impacted by spill-over from the Iran tensions and regional instability,” says Richard Robinson, Middle East analyst at Oxford Analytica.
While the prospect of war is “very limited”, according to his assessments, the perception of rising risk is impacting businesses operating in the region.
“We know that several oil companies have started to beef up the security presence on their ships,” Robinson says. “It also pushes up insurance costs for shipping in the region. That’s something that impacts everybody because it increases the costs for a large number of firms that operate in the Gulf.”
The recent events in the Gulf are closely monitored by insurance firms underwriting trade in the region. Rupert Boyle, executive director of credit and political risks at Gallagher, confirms that they are starting to impact insurance premiums.
“One effect on the market so far is that it has pushed up the war-rates on any ship operator going through the straits,” he says. “The underwriters are also imposing limits on amount of time that the ship operators can spend within the region.”
He adds that insurers underwriting cargo are now also demanding additional premiums for war coverage. Previously such coverage had been granted gratis with conventional cargo coverage.
Boyle has also started to see a growing uptake of insurance coverage on direct inward investment into the region.
“When it comes to infrastructure projects going on within the region, we have seen that there has been more active buying of coverage from the market, with coverage specifically being bought to cover contract frustration in the event of the straits being closed,” he says.
This coverage does not involve Iran itself. Because most insurance companies operate with US-linked capital and therefore have to adhere to US sanctions, Boyle says “it’s virtually impossible doing anything involving Iranians”.
But he says insurers continue to have appetite for supporting transactions elsewhere in the region.
“Everything is beginning to get more expensive, but because there hasn’t been a truly heavy incident yet, there is still appetite to write business in the region,” Boyle explains. “But there is a perception that generally the states in the region are becoming more vulnerable and so underwriters at some point are probably going to take their foot off the accelerator. Should there be a somewhat more substantial incident, let’s say the Iranians try to close the straits, then of course you are shifting into a completely new ballgame, at which point I think the market will back off.”
Boyle, who also works with financiers, says that so far he hasn’t seen impact on margins for financing in the region, adding that “there is still plenty of liquidity”.
According to Robinson at Oxford Analytica, the recent incidents in the Gulf are indicative of a policy change by Iran towards “calculated escalation”, which has been unfolding since early May when Iranian President Hassan Rouhani announced that Iran would begin rolling back its adherence to commitments under the Iran nuclear deal – officially known as the Joint Comprehensive Plan of Action (JCPOA).
It came in response to Trump’s decision last year to withdraw the US from the agreement, which saw Washington reimpose secondary sanctions against Iran in areas such as shipping, energy, financial services and insurance.
Trump’s move has posed a range of challenges to companies around the world: the secondary nature of the sanctions means that even non-US firms could be punished by the US if they deal with sanctioned Iran business. Meanwhile, the sanctions have forced the international banking system to cut ties with Iranian financial institutions, making it close to impossible to move money into and out of the country.
Following Rouhani’s announcement, in early July Iran raised the level of uranium enrichment, with Iranian officials saying they will continue to reduce the country’s adherence to the JCPOA unless European nations can protect it from the economic damage caused by US sanctions.
European officials, meanwhile, continue to officially back the JCPOA. According to Robinson, it seems that the European signatories to the deal – the UK, France and Germany – want to keep the question of the JCPOA separate from the escalating tensions in the Gulf. “Obviously they have condemned the security violations in the Strait of Hormuz, but I don’t think they really want to tie that in together with the JCPOA,” he says.
Rather, his expectation is that Europe will have to accept what he calls “a weakened nuclear deal”, basically allowing Iran to ignore several of its commitments.
“As Iran continues to allow IAEA inspectors access to its facilities, a watered-down JCPOA may represent the best way to ensure its nuclear programme is kept in check,” Robinson writes in a research note. “Moreover, the deal’s survival in some form is likely viewed as the only available off-ramp to current tensions.”
The impact of this on trade with Iran under the JCPOA will likely be limited, given that most companies around the world are already hesitant to do business with Iran in light of US sanctions. “Trade is there but it’s not substantial,” says Robinson.
The EU has made several attempts to counter Trump’s unilateral sanctions and support European trade with Iran. For example, it has amended its so-called ‘blocking statute’ to include the new range of sanctions. The regulation effectively prohibits EU people and entities from complying with the US requirements, but experts have claimed this to be more of a political statement than of any real help for EU companies, referring to the fact that enforcement of the blocking regulation has been very low across the EU in the past.
In February, meanwhile, the UK, Germany and France launched a new payments mechanism that allows European companies to trade with Iran without having to go through the formal financial routes. Instex – short for ‘Instrument for Supporting Trade Exchanges’ – works as a barter system that facilitates the exchange of goods between Iran and Europe without money changing hands.
The mechanism is limited to processing non-sanctionable humanitarian trade, such as food and machineries. Yet, using Instex could put firms on a collision course with Washington, with the Trump administration cautioning that anyone engaging in sanctionable activity involving Iran “risks severe consequences that could include losing access to the US financial system and the ability to do business with the US”.
As a result, many companies are hesitant to use Instex. “Unfortunately, no major operations have benefited from it,” says Katayoon Valizadeh, a senior consultant in credit insurance and risk management in Tehran and former manager at the Export Guarantee Fund of Iran. “The major reason is that European authorities are not decisive enough – because of their interests with the US – to push Instex into operational phase. And even if the European governments tried to support this channel, businesses, especially big companies that have business with the US, are not willing to use it, because they can be sanctioned.”
Her comments are echoed by Robinson, who emphasises the fact that the US has threatened to sanction Instex itself, which could scare even more companies away. “Even if the mechanism worked very efficiently, our prediction is that it would still be quite limiting in terms of achieving its purpose of expanding trade with Iran, simply because companies in Europe don’t want to touch it,” he says.
Whether Instex and other potential measures by Europe will be effective is yet to be seen, but as long as they are seen as ineffective by Iran, the country will likely continue its current strategy of “calculated escalation”. Although at this point experts don’t anticipate military confrontation, the sentiment is that the US-Iran spat doesn’t look to be going away anytime soon. Meanwhile, companies with exposure in the region are advised to prepare themselves for more disruption.
“These incidents and events are being played out publicly and in real time, so although companies with operational exposure to the area cannot control the situation, they can still be active in preparing and positioning themselves,” says Richard Phelps, senior director of business intelligence at investigations firm Kroll. “This should include live monitoring of the evolving situation, developing tailored crisis management plans and contingency protocols that are relevant to their assets and employees, and preparing themselves for making appropriate decisions should they need to.”