Once again in the Middle East, the Strait of Hormuz is a symbol of the delicate but tense nature of relations in the region. Only 21 miles wide at its narrowest point, and with shipping lanes only 2 miles wide to ferry a fifth of the world's oil trade, it is a choke point in all senses of the word. If closed or blocked, attempts to reopen the strait would concern all of the world's powers.
A diplomatic solution to Iran's development of nuclear capabilities continues. But facing increased economic sanctions, Iran has engaged in belligerent dialogue with the U.S. and its Western allies in recent weeks, making the strait's closure a remote possibility. The latest pronouncement by Iran's ambassador to the United Nations reiterated that if threatened, his country would not rule out blocking the strait.
The obvious implications of any closure of the Hormuz Strait are stark. According to the U.S. Energy Information Administration, almost 17 million barrels of oil were transported daily through the Strait last year, representing nearly 20% of global oil trade. (Most Gulf oil exports now head to Asia.) A number of analysts predict prices for oil would jump 100%. Non-oil shipping would be affected as well; near the Gulf's center, Dubai has the ninth-largest sea shipping port in the world.
Despite the sudden sharp increase in the price of oil that would result, oil exporters surrounding Iran in the Gulf would not benefit from the situation. Instead, they would be dealing with sudden, short-term economic pressures, including increased security and logistical costs, a fleeing expatriate workforce, flight of investment capital and a squeeze on resource demands.
"There would be severe implications for the global economy," says Giyas Gokkent, group chief economist with the National Bank of Abu Dhabi. "And it's hard to say anyone in the region would benefit from the strait's closure. Even if oil prices go up, the price of that pales in comparison to the damage that would be done to the region's non-oil sectors, in that type of environment."
The Most Exposed
The Arab countries that sit closest to Iran form the Gulf Cooperation Council — Kuwait, Bahrain, Qatar, Saudi Arabia, the United Arab Emirates and Oman. But closure of the strait would completely affect only the first three due to their geography. Saudi Arabia's lands expand to the Red Sea, and ports also exist there to facilitate shipping. The UAE has nearly completed work on the Abu Dhabi Crude Oil Pipeline that will deliver oil to the port of Fujairah just south of the Strait, and Oman also has open coastline away from the strait.
During Iran's near decade-long conflict with Iraq — a conflict that started partly over use of another waterway — it attacked Iraqi and Kuwaiti oil tankers in the Hormuz Strait. Iran also has ongoing territorial disputes with the UAE over a collection of islands in the Strait. Since the 1980s, a number of hostile incidents have occurred between Iranian forces and the U.S. Navy in the Strait, which maintains its Fifth Fleet headquarters in Bahrain and another base in Kuwait. (The Iranian mine that nearly sank the U.S.S. Samuel B. Roberts in 1988 cost only US$1,500, but inflicted almost US$90 million in damage).
Yet there are historical trade ties between Iran and its Arab neighbors as well, and a number of the Gulf countries have absorbed Iranian immigrants. In countries such as Qatar and Bahrain, they have naturalized and become part of local society. In 2010, exports from the UAE to Iran were worth over US$9 billion. Much of that flow was generated through Dubai, the UAE's tourism and trading hub, which features a large population of Iranians and Iranian businesses.
Analysts say although any Iranian closure of the Strait would be brief at best, a conflict would pose immediate security and logistical challenges for the Arab countries: Protection from a possible Iranian guerilla strike against oil refineries, water desalination facilities and passing ships, and figuring out alternative ways to see goods in and oil delivered out of the region.
"If Iran attacked a tanker or mined the passageway, it would take the U.S. a couple of weeks before it felt it had a concentrated enough force to confront Iran in a determined fashion," says Farid Abolfathi, senior director of the Risk Center at IHS Global Insight in Washington, D.C. "It would take a couple of months to clear the passageway if it was mined. That doesn't mean tankers and ships wouldn't go through. But they'd be taking on the risk, with no insurance, and rates would go sky high."
With an eye to Iran, Arab Gulf countries have already spent billions on defense budgets. A number of analysts peg the Gulf region's arms spending last year at upwards of $US70 billion. In June, Saudi Arabia awarded Raytheon a $US1.7 billion contract to upgrade its missile defense network. With the recent allocation of millions of dollars in spending to buttress against social discontent that led to Arab Spring protests in other countries, conflict with Iran would create additional budgetary pressure in the form of emergency defense spending, and even higher demands for defense outlays.
"There would be an impact on government consumption," notes Said Hirsh, a Middle East economist with London-based Capital Economics. "Despite (Arab Gulf countries') low debt and high oil revenues, it's unsustainable for budgets."
Conflict Brings Costs
Extra spending would be needed to handle logistical and operational issues too. In the case of the Hormuz Strait being blocked or closed, that would mean having to pay more for imports going through alternative, costlier routes, with higher insurance rates for shipping, and higher fuel costs.
That would be unwelcome for economies like the UAE, which cannot exist without vital imports of food and other goods. Currently, the Gulf country imports more than 80% of its food supply, spending US$680 million in 2010. Only last January did the country announce it would create a strategic food reserve to deal with sudden shortages.
In an attempt to economically diversify, the UAE and its neighbors have built up their non-oil sectors, including trade, tourism, real estate and financial services. Dubai has been the most successful, with wholesale and retail contributing 30% of its 2010 GDP, according to the Dubai Statistics Center.
The Emirate has also managed to capitalize on the Arab Spring, presenting itself as a regional safe haven for businesses and investors. Dubai is among the Gulf economies seeing a slow comeback of its real estate market, which accounted for 30% of its GDP before the 2008 global financial crisis began. But a conflict in the Strait would jeopardize that status, and deflate investor confidence.
"The UAE is an important trade hub, and that trade would be disrupted," says the National Bank of Abu Dhabi's Gokkent. "Business, finance, retail, hospitality, logistics, aviation, all of those sectors would be negatively affected."
Another import that Gulf economies rely heavily on is human capital. Estimates put expatriates across the Arab Gulf accounting for roughly 40% of the region's total population. In the event of a conflict, a sizable number would be expected to flee the region for safety. "Undoubtedly people will leave," Hirsh says. "We saw that during the terror attacks in Saudi Arabia about eight years ago. They would want to leave in terms of a full-scale conflict. Others would be paid a lot more to stay."
An added loss would be an expected flight of investment capital from the region, particularly foreign direct investment funds. That would be untimely for the Gulf's markets, which have already suffered losses this past year. According to Zawya, Gulf bourses lost US$52 billion last year on Arab Spring and euro concerns. "Capital is not flowing freely in the region," Hirsh says. "It had a bad year, and [a conflict] would mean another bad year. We need FDI to kick-start the region."
But the Arab Gulf countries would not see stagnation or idling of their economies with the Strait closed, says Global Insight's Abolfathi. "I don't expect a sharp decline in economic activity," he says. "I don't know if a crisis would last long enough to damage those economies. Usually when there is a military crisis, markets dive, but when fighting starts, it rebuilds."
Saudi Arabiawould utilize its Red Sea ports for shipping, he adds, and the Gulf of Oman would not be impacted as well. "Iraq can import through Jordan, even Kuwait can go through Jordan. It would disrupt a lot of trading in Dubai, but it would not affect the economy of Abu Dhabi. But the impact on Iran would be huge."
Block Or Bluff?
Because closing the Hormuz Strait would affect Iran more than any other country in the region — unlike its neighbors, it has no other way of importing or exporting its oil — most analysts feel it is unlikely to take such a move. Another reason, they argue, is because Iranian leadership understands it would be facing overwhelming U.S. military might, and global condemnation.
"It would be an extreme scenario, involving an extreme response from the U.S.," says David Butter, the Economist Intelligence Unit's regional director for Middle East and North Africa. Alongside Western allies and NATO, Butter says even China would consider a response. It would be a situation that the Gulf countries would support a quick end to, he adds. "They would be very heavily exposed."
Butter notes that much would depend on how effective the latest round of economic sanctions will be in bringing Iran to negotiate its nuclear capabilities development, or to help opposition within build enough to challenge the regime. "You want to make it more difficult for Iran to sell its oil. You want to hurt Iran, you don't want to push it over the edge."
He adds, "If sanctions work too well, and Iran's oil exports are driven down to 1 million barrels a day or less, they will have a hard time paying for even necessities – then Iran has nothing to lose. It's potentially a dangerous game being played here."
Abolfathi predicts a conflict between the U.S. and its allies versus Iran would be quick and decisive. "In 1991, Iraq was the fourth most powerful force in the world," he says. "The U.S. reduced it to a whimpering animal. Iran is no where close to what Iraq had then."
The lesson for Gulf countries from that conflict, Abolfathi says, is that Iran's ambitions must be contained. "Iran doesn't have nuclear weapons, but if it does, it might become as aggressive as Iraq did."
Gulf oil exporters would do well to heed the experience of Kuwait, Butter adds, after its invasion by Iraq in 1991. When it was occupied, its oil industry was damaged, he notes, and yet the leadership has only focused on investing externally. "Kuwait's infrastructure hasn't been very developed," he says. "Their policies did not change even in light of the war."
Hirsh adds that just the threat of conflict in the region should give Gulf leadership pause about their policies. "Because of the Arab Spring, these countries have increased spending. How do they manage funds from a long-term perspective, rather than knee-jerk reactions to events?"