How the conflict in Yemen is impacting the oil market

The escalating battle in Saudi Arabia’s neighbour has already rippled crude prices as a coalition that includes the UAE launched bombing raids last week. The situation is reminder of the impact local conflicts can have.

Yemen's foreign minister Riyadh Yaseen attends the closing session of the Arab League summit in Sharm El-Sheikh, on March 29, 2015. Amr Abdallah Dalsh / Reuters

The worsening conflict in Yemen – which pits rival internal groups backed by Iran against those backed by a Saudi Arabia-led coalition of countries – brings to the fore again the potential such regional flash points have to disrupt world oil trade.

Even before the coalition, which includes the UAE, took direct military action midweek, bombing Iranian-backed Houthi rebel positions, the risks of Yemen’s civil war spreading had been filtering through to the oil market.

World benchmark North Sea Brent crude oil had one of its strongest gains this year, rising by more than 7 per cent last Wednesday and Thursday, to US$59.19, before bearish sentiment reasserted itself and Brent plunged $2.78 on Friday to end at $56.41.

Brent was down 62 cents at $55.79 on Monday. The decline was partly attributed to the growing prospect that Iran will reach agreement with international negotiators on its nuclear programme, thus illustrating the dominance of regional political concerns over the oil market.

Oil traders say the earlier gains came as the Houthi faction captured more ground in Yemen and was followed by air strikes by Saudi Arabia, Egypt and others against Houthi positions, including in and around the capital Sana’a. Saudi officials have not ruled out a ground incursion and on Saturday, Yemen’s foreign minister, Riyadh Yaseen, said he expected coalition troops to be in Yemen within days.

The fighting in Yemen has been going on for years, but the latest intervention represents a step-change in that conflict and the risks it carries to regional trade flows, says Firas Abi Ali, the head of Middle East analysis at IHS Country Risk.

“The crucial aspect of Saudi Arabia’s intervention in Yemen is that it represents a change from using its own proxies to fight Iran’s proxies, to taking on Iran’s proxies directly,” Mr Abi Ali says. He says the coalition now feels that core interests, including the security of the Bab Al Mandeb Strait at the southern end of the Red Sea, “are sufficiently under threat to warrant direct involvement”.

Yemen itself has oil and gas resources but exports only a relatively small amount. Yet the oil market perceives the major risk to be the possibility that fighting spills over and affects the Bab Al Mandeb Strait off Yemen’s south-west coast. It is one of the world’s oil trade chokepoints, through which flows about 4 million barrels a day of crude, representing about 7 per cent of global seaborne oil trade.

“Minor naval incidents between Iranian and Saudi or Egyptian vessels off the coast of Yemen, including near Bab Al Mandeb, are increasingly likely, raising the risk of collateral damage to shipping in transit across the straits and disruption to strategic oil cargo routes, which will have an impact on the oil market,” Mr Abi Ali says.

Yemen’s own proved reserves are about 3 billion barrels of oil and 17 trillion cubic feet of gas. However, the country is a relatively small oil and gas producer and the conflict is adding to a decline in production. Its average production last year was 130,000 barrels per day, down from a peak in 2001 of 440,000 bpd.

Yemen recently began producing natural gas at a rate of about 300 billion cubic feet a year, with 90 per cent of that being exported via the Balhaf LNG terminal. The terminal loaded 6.1 million tonnes of liquefied natural gas last year, representing slightly less than 3 per cent of the global market. However, oil and gas exports made up almost 90 per cent of total export revenues and two thirds of government revenues, so are extremely important targets for control in the internal conflict. There are a dozen oil and gas concessions currently in production in Yemen but Total of France is the only major oil company there. It has interests in several blocks and is the operator of the Balhaf LNG terminal. Other foreign companies that had been operating there include DNO, which is 42.8 per cent owned by RAK Petroleum, OMV, part-owned by Ipic, as well as Occidental Petroleum, China’s Nexen and Korea National Oil Company.

“Due to the worsening security and political environment over the last five years, foreign companies have been scaling back their presence and investment plans,” says Richard Mallinson, a Middle East analyst at Energy Aspects. “Recent months have brought an escalation in the risks for foreign companies in Yemen, even compared to the previous challenging environment,” he adds, pointing out that in January, the governor of Shabwa province ordered about 50 thousand bpd of production to be shut down in protest over the Houthi actions in Sana’a.

China-owned Nexen halted operations at the East Al Hajr field in January when it came under direct threat and decided to relinquish its licence, as did DNO, TransGlobe and Dove Energy.

Occidental evacuated foreign staff in January after Houthi troops raided its offices in Sana’a and OMV has also flown staff out and scaled back operations.

Yesterday, Reuters news agency reported that Total had evacuated all expatriate staff from Sana’a and Kharir but was maintaining LNG production and exports via Balhaf. “All necessary measures are in place in order to ensure maximum security conditions for the people remaining,” a spokeswoman said.

Total had previously said, however, operations on Yemen’s Block 10 had been cut, with gas production maintained only for local power generation and to supply local communities.

It is not just the threat to local shipping and the disintegration of Yemen’s domestic hydrocarbons sector that poses a threat. A prolonged civil war in Yemen might see refugees flow into neighbouring countries, especially Saudi Arabia and Oman with the potential to sow civil strife there. Still, as with other conflicts in the region, the direct impact on oil markets is difficult to predict.

“The risk has increased but put in context that risk is now probably very rare instances where vessels from Iran trying to re-supply the Houthi rebels might end up getting involved in confrontations,” says Mr Abi Ali. “That is very different from saying the Bab Al Mandeb strait will be shut. That is extremely unlikely.”

There are naval vessels from the US, EU, China and others patrolling near the straits. They have been effective in reducing the incidents of piracy that had been disrupting oil tankers and other vessels passing by the Gulf of Aden. Their continued presence is likely to reduce the chances of any kind of Yemen-related incident shutting the strait.

This assessment was beginning to be realised in the oil market at the end of the week, when prices fell back. As Mr Abi Ali notes, even at the height of the Iran-Iraq war in the 1980s, when tankers were sunk, the disruption did not last long – and neither did the oil price spike.

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