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Base Oil Importers Fear Middle East Supply Disruption

Smoldering tensions between the United States and Iran are stoking fears that Middle Eastern base oil shipments may be disrupted, as the standoff threatens to spark a direct confrontation. But U.S. President Donald Trumps determination to choke Iranian exports is being hampered by Chinas defiance of his sanctions policy, amid a bitter trade dispute between Washington D.C. and Beijing. Recent reports say China continued imports of base oil from Iran during July, albeit at lower levels than a year earlier.

Analysts warn a sudden escalation of hostilities could see critical infrastructure such as refining assets targeted, as a U.S.-led effort to protect shipping through the strategic Strait of Hormuz threatens to draw Tehrans ire.

This uncertainty is undermining the Middle Easts position as a stable base oil supply source, despite hefty investment in new production capacity. Countries including China, India and South Korea have become increasingly reliant on API Group I base stocks from Iran, as well as new Group II and III supply from Bahrain, Saudi Arabia and the United Arab Emirates.

Asian clients, especially China, India and Japan, should be worried at present, the security situation surrounding the Gulf is under severe pressure, said Cyril Widdershoven, direc-tor at Dutch risk consultancy Verocy.

Base oil shipments from the U.S. to the Middle East are also likely to be affected by rising insurance costs and worries over mounting risk. Last year, U.S. refiners exported just under 55,000 metric tons of mostly Group II base stocks to the region, according to ClipperData, a company that tracks U.S. base oil exports as well as trade flows in Asia, Europe and the Middle East by grade.

But Widdershoven says disruption to critical infrastructure could be achieved without military operations, as both the U.S. and Iran, have powerful cyber warfare capabilities.

Although the risk to cargoes has increased, tensions have not yet reached a point where they will hinder shipments despite the rise in combative rhetoric, said one base oil executive in Tehran who asked not to be named.

Trade flows will not stop unless two things happen. First, [the] U.A.E. rejects all base oil shipments knowingly from Iran, and the same happens in Southeast Asia. Second, which is the harshest scenario, a sea blockade by armed forces.

The same person added that the more likely outcome is a squeeze on profitability. Insurance policy increases will affect competitiveness and drive refiners margins lower, and the recent jump in crude prices will also increase costs.

Still, halting Irans base oil exports is not as straightforward as it might seem. The U.A.E. has become the epicenter for regional base oil re-exports, often involving ship-to-ship transfers of cargoes originating from Iran. The emirates have come under intense pressure from the U.S. to cut Irans supply artery, though it is not clear if Iranian-origin cargoes continue to reach the U.A.E. indirectly. Nonetheless, the threat of prosecution and erosion of sentiment have cut a swathe through the livelihood of regional base oil traders, particularly in the U.A.E.

Local traders have reported a steep increase in bankruptcies amid hefty price discounts, as the remaining base oil traders and lubricant marketers battle for survival. The downward spiral has been precipitated by tight credit conditions, as banks wind down exposure to the sector.

Confidence has been also dented among shipowners who are increasingly risk averse. A spokesperson from Emarat Maritime, a shipping company based in Dubais Port Rashid, said some crews are refusing to come to the region following an increase in tensions and attacks on ships off the U.A.E. coast. That has led to accusations that some vessel owners are seeking to profit from the uncertainty.

Even so, Irans deftness at skirting sanctions is well known, with evidence that the administration continues to find alternative routes to maintain supply. Attention has turned to the Indian-managed port of Chabahar in Southeastern Iran. It remains the only Iranian port not subject to U.S. sanctions, acknowledged by the U.S. government as a vital conduit to Afghanistan. But its deepwater capability could see Chabahar emerge as a transshipment hub, although analysts play down how readily Iran will be able to use the facility under the glare of sanctions.

Nonetheless, unease from base oil customers in Asia over the possibility of interruptions to supplies is clearly on the radar of Gulf refiners. Saudi Aramco moved quickly to reassure customers over the possibility of supply disruption. In June, its President and CEO Amin Nasser said in an interview in Seoul, We are increasing our readiness.

Although the Saudi Arabian oil giant can switch crude supply through a pipeline to the Red Sea, it is uncertain what its strategy would be if base oil exports are curtailed.

Asias preoccupation with supply continuity may open the door to U.S. base oil refiners as a hedge against further instability in the Middle East. With the cost of Middle East cargoes rising, U.S. exporters may be increasingly competitive, despite longer average shipping times. Any gain will be tempered by the U.S.-China trade dispute and Beijings decision to throw its weight behind Iran in the current dispute.

Even if current tensions ease, walking back to normality will take time, as both administrations in Tehran and Washington scrabble around for coherent strategies. In the meantime, markets are stuck in a no mans land, reliant on the complex signaling between the U.S. and Iran that without notice could quickly unravel traditional trade routes, upending major economies in the process.

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