What Are The Worst Case Scenarios For Oil Markets

Israel-Iran strikes have taken a dangerous turn in recent days. They follow an attack by Israel on the Iran’s military and nuclear sites. Ever since tensions escalated on Friday, there have been calls for restraint from the United Nations, U.S., U.K., and European Union but to no avail.

Fighting has so far been restricted to the two warring countries. However, the level of the ferocity of the strikes has raised the alarming prospect of a wider conflict in a region that is a key exporter of crude oil.

On Friday, Israel’s Prime Minister Benjamin Netanyahu said his country’s forces had struck nuclear and military targets deep inside Iran and that action will continue until his country has met all its targets.

Israeli strikes targeted sites in Arak and Isfahan, as well as Iran’s main uranium enrichment site Natanz and its capital Tehran. In retaliation, Iran has launched over a 200 ballistic missile attacks against Israel so far, and counting.

It has also called off the ongoing U.S.-Iran nuclear talks and threatened to attack U.S., U.K. and French military bases and ships in the region if they help with stopping its military strikes on Israel.

Critically, Iran’s oil and gas infrastructure has been left somewhat untouched by Israel. But given the unpredictability of the situation, this can no longer be ruled out. Late on Saturday, the Shahran oil depot in Tehran was hit by Israel, following on from earlier attacks on Iranian natural gas fields.

Should Iran’s energy infrastructure be hit more widely and the Islamic Republic retaliates to disrupt regional energy supplies or to draw the U.S. into the conflict, there could be consequences of varying degrees of severity for the oil market.

Here are a five worst case scenarios, split between what Israel and Iran may do next in an unpredictable and rapidly escalating conflict.

Israel Takes Out Kharg Oil Terminal

Israel may launch an attack on Kharg Oil Terminal, situated on Kharg Island, 15 miles off Iran’s northwestern coast. The terminal handles over 90% of the country’s global crude oil exports.

If such an attack cripples the facility, the domino effect could be instant. It carries the potential for huge disruption, primarily to Iran’s exports to China — the world’s largest importer of oil.

Not only would it contribute to a further short-term spike in prices, but forward oil futures contracts four to six months out may also see upswings. That’s because bringing it back onstream would neither be easy nor quick.

Israel Clobbers Iran’s Domestic Supply Chain

Instead of a high profile oil export target like the Kharg Terminal, Israel could hammer Iran’s domestic energy chain. The Shahran oil depot in Tehran on Saturday by Israel lends weight to this theory.

Upscaling the tactic may involve targeting a bigger cluster of oil terminals and hubs in the Southern province of Hormozgan. The region is also home to two free trade zones on Kish and Qeshm Islands. Kish also hosts the Iranian oil bourse — the only exchange of its kind that does not trade oil and derivatives in U.S. dollars.

The domestically focused Abadan Refinery – located across Shatt Al-Arab River on the border between Iraq and Iran – could also be an Israeli target. Reliable up-to-date data on the refinery’s production capacity is hard to find. But estimates and regional media sources (e.g. Financial Tribune) suggest it could be producing around 400,000 barrels per day.

Abadan has symbolic status too as Iran’s oldest oil processing facility. Originally built in 1909 by Anglo-Persian oil (which later became BP), it services around 25% of Iran’s domestic fuel demand. Any outages there could be crippling for both Iranian consumers as well as the country’s military.

Mahshahr Oil Terminal, an oil port located on the Khor Musa Channel, is a related target. It stores and shifts products from the Abadan Refinery, and serves as an engineering and jetty construction hub for Iran. If any of these are hit, Iran’s domestic supply chain will likely be severely crippled and may require Tehran to redirect resources.

Israel Cripples Iran’s Natural Gas Industry

Instead of targeting oil production and export facilities, Israel may execute a plan to cripple Iran’s natural gas industry. Iran produces just over 270 billion cubic meters of natural gas per year, almost entirely for domestic use.

Israel has already attacked two of Iran’s gas fields, including Phase 14 of South Pars so far. The attacks could be a harbinger of what may follow. Such targets would have nominal ramifications for the global natural gas industry, although Iran does share the natural gas basin with Qatar.

However, Iran’s natural gas production volume equates to just above 6% of the world’s output. Domestic outages may see Tehran turning to alternative liquefied natural gas supplies to meet its needs, which may again prove challenging in the face of international sanctions.

Iran Attempts To Shut Down The Strait of Hormuz

For its retaliatory measures, many ponder if Iran could shut down the Strait of Hormuz, a key maritime artery for oil and LNG shipments from the Persian Gulf out to the Gulf of Oman and beyond (see map below).

Cargo volumes lend relevance to such discussions. Iran’s own shipments, plus that of Saudi Arabia, Kuwait, Iraq, and to an extent United Arab Emirates’ crude – roughly equating to 30% of the world’s traded oil – as well as Qatar’s LNG cargoes pass through the Strait daily.

While Iranians could certainly attempt to close the Strait, they most probably won’t, despite junior political voices in the country currently calling for it. For starters, it would disrupt Iran’s own oil shipments.

Furthermore, a U.S.-led global retaliation may likely follow that would leave Iran’s own coastline and all its ports vulnerable to a vastly superior American air and naval strike arsenal. Nearby Bahrain is home to the U.S. Navy’s Fifth Fleet.

Any disruption would also irk Iran’s number crude oil customer – China. Iran exported on average 1.65 million bpd of oil to China last year. Furthermore, nearly half of crude oil passing through the Strait – whether Iranian or not – in the region of 20.5 million bpd also heads to China. A potential blockade would be very difficult to maintain under pressure from Beijing, the world’s main taker of Middle Eastern oil.

Iran Attacks Gulf Military Bases And Oil Facilities

In an attempt to drag the U.S. into the conflict, Iran may either directly or via its regional proxies in Iraq, Yemen, Lebanon, West Bank and Gaza, attack the energy infrastructure of neighboring Gulf states.

This has alleged precedent, for in the past Iran has been accused of targeting Saudi Arabia’s oil fields (2019) and an attack in the UAE (2022). While the route of direct attacks remains open to Iran, its regional proxies Hamas and Hezbollah are severely diminished at the moment courtesy of Israel’s sustained campaign against them.

However, the Houthi Rebels in Yemen – the last standing Iranian proxy ally – remain in a position to ramp up their attacks on commercial shipping, and oil and gas cargoes in the Red Sea – a campaign that began in 2023.

Sidestepping energy infrastructure, on Saturday, Iranian officials also warned that the country would attack the military bases of the U.S., U.K. and France in the region, if they are seen to be coming to Israel’s defense. All three nations have also have special forces camps and large diplomatic missions in the Gulf.

Such a scenario is being widely contemplated in intelligence circles, with U.S. regional forces closely monitoring the situation and the U.K. opting to send more military aircraft to its bases “for contingency support across the region.”

Any such escalation will likely trigger a wider regional war, and prolonged disruption to oil cargoes will likely draw China into a diplomatic row too.

As things stand, should one or more of the above scenarios, especially an attack on Iran’s Kharg Terminal, materialize during the Israel-Iran strikes, there could be serious ramifications for the world’s oil and gas markets. As a consequence, higher near-term energy prices beckon.