The extraordinary risk of targeting regional energy assets

For nearly a year, the ongoing regional conflict, which started as a war between Israel and Hamas, seemed to contradict the old formula long thought to be one of the few certainties in global petroleum markets: that “war + Middle East = high oil prices.”

While the conflict has taken an immeasurable toll in human lives and negatively impacted the economies of all those involved, the region’s energy sector had largely been spared. There have been isolated incidents ostensibly targeting Israeli natural gas production, but the parties to this conflict have thus far proven uninterested or unable to launch major, successful attacks against any of those energy facilities. The disruption of maritime traffic in the Red Sea by the Iran-backed Houthis is indeed an ongoing problem with no clear resolution, but it does not constitute a significant threat to the availability of energy supplies from the region and has largely become a fact of life that the market has now priced in.

Yet the potential for the conflict to begin having a much more direct impact on markets due to fast-emerging risks to the regional energy sector crystalized last week. Israeli suggestions that Iran’s oil sector could become a target in retaliation for Tehran’s recent ballistic missile attack on its territory were taken seriously by a market that had otherwise appeared largely immune to the conflict, with benchmark prices reacting in the form of a near $10 per barrel increase in the space of a single week. Iran likewise threatened to target Israeli energy production, and it has similarly been suggested that either Tehran or its proxies could strike at energy facilities in the Arab Gulf states. The mere possibility of this outcome raises the specter of a cycle of retaliation that could do untold damage to regional energy production were it to spiral out of control.

Spillover to the Gulf

The potential for Israel to target Iran’s refining sector, which has an output of 2.5 million barrels per day (bpd), has been presented as an option that would have a more limited impact on global markets, as the sector primarily services domestic demand. The supposed logic behind this course of action is to provide an alternative to a direct attack on Iran’s oil production (which its refineries need to produce fuel and other products) or export terminals. Although damaging or destroying export infrastructure would surely be the most direct way to limit Iran’s oil revenue, it would also be impossible to avoid some form of a subsequent price spike. Washington is doubtlessly keen to avoid a major jump in oil prices from the loss of Iranian supply, particularly so close to a hotly contested election. China, currently the only real buyer of Iran’s heavily sanctioned oil exports, imported around 1.4 million bpd from Iran in September. Depriving Chinese buyers of this supply would force Beijing to seek additional barrels elsewhere, although this would not likely have a major effect on what is currently a well-supplied market.

While this development in and of itself would not be disastrous due to relatively plentiful supply and weaker overall demand in 2024, any ensuing impact on production or shipping in the Gulf region is another question entirely. OPEC+ could easily replace the lost Iranian supply due to the 5 to 6 million bpd in spare production capacity it currently holds as the result of ongoing, deep production cuts. However, if events unfold in such a manner that makes that capacity difficult or impossible to access, namely Iran or its proxies carrying out a retaliatory strike on the Gulf’s energy sector, then the potential for a major supply shock would become a nearly forgone conclusion, the effects of which would reverberate across global markets.

Around 30% of world crude oil volumes and 20% of refined products (liquids such as gasoline and diesel) sail from the Gulf. Before fully laden tankers carrying these volumes transit the Strait of Hormuz, which is often touted as a potential chokepoint for the energy trade in the event of a conflict, these vessels take on cargo at a handful of export terminals around the region. These facilities could themselves present a bottleneck for the flow of supply from the Gulf. Export terminals such as Juaymah or Ras Tanura in Saudi Arabia and Das Island or Zirku Island in Abu Dhabi collectively exported 6.2 million bpd of crude and condensate in September, highlighting the major export volumes shared between just these few key facilities. While oil can be exported from the Gulf via routes other than the strait, such as Saudi Arabia’s East-West Pipeline or ADNOC’s pipeline that runs from Abu Dhabi to Fujairah, the infrastructure that makes these alternate routes a plausible option is no less exposed to the conflict, in addition to the fact that their overall capacity is significantly lower than that of flagship installations. In the case of Saudi Arabia, its 5 million bpd East-West Pipeline links output to terminals on the Red Sea, which in addition to throttling its exports would require Saudi cargoes to brave ongoing instability around the Bab el-Mandeb, given that around 70% of its overall crude and condensate exports head to Asian markets.

Israel impact

Although Israel’s natural gas production is not particularly well-integrated with global liquefied natural gas (LNG) markets, it does export significant pipeline volumes to both Egypt and Jordan, making the threat of a major attack on production significant to the lives of energy consumers in each country. Iranian threats of retaliation against the Israeli energy sector, should Israel attack Iranian assets, must be treated with the utmost seriousness. Leviathan, Israel’s largest producing field, exported just under 90% of its total production to Egypt and Jordan in the first half of 2024.

In its current state of affairs, Egypt is in a uniquely vulnerable position. During a month-long shutdown of a single Israeli gas field last October, at the outset of the conflict, Cairo had to impose blackouts to manage the shortfall in Israeli gas imports, on which it is heavily dependent for power generation. With its rapid demand growth continuing to outpace its ability to raise domestic production, Egypt will have few other alternatives than to turn to LNG imports should it lose access to pipeline volumes from Israel. Additionally, the need to import these volumes holds the potential to tighten LNG markets, resulting in more expensive energy imports for European markets as well as for Egypt at a time when it can ill-afford them.

Conclusion

While an attack on Iran’s refining sector appears calibrated with the intent of avoiding a wider supply shock in global markets, there is little to no guarantee of such an outcome, and it is one that appears increasingly less likely with the passage of time. In fact, if this conflict enters a phase in which direct targeting of energy assets becomes the norm, it will matter little where it began, as nearly the entirety of the regional landscape from the eastern Mediterranean to the Gulf is dotted with what could potentially be construed as high-value targets. A sustained cycle of escalation in this direction represents a dire threat to global markets that are only recently recovering from the geopolitical volatility of 2022 and would threaten the daily energy supply and livelihoods of millions in the region itself. Producing countries dependent on export revenues to fund national budgets or diversify their economies for a post-oil era would lose billions in revenue in the process and face untold setbacks in preparing for the energy transition.

Israeli capabilities have been on full display throughout the conflict and should leave little doubt of its ability to engage energy targets as it sees fit. Iran’s undeniable hand in the 2019 attack on Saudi Aramco processing facilities at Abqaiq should likewise confirm its ability to target similar installations with remarkable precision. As a result, the use of strikes on energy assets as a means of exerting some form of leverage in this conflict should be treated with extreme caution; seemingly short-term strategic gains may lead to unprecedented levels of damage to the economies of the region and beyond.

Colby Connelly is the director of MEI's Economics and Energy Program. He is also a senior analyst at Energy Intelligence, where he works with the firm’s research and advisory practices.

Photo by Ali Mohammadi/Bloomberg via Getty Images