Middle East conflict halts Hormuz shipping as oil markets brace for impact

The assassination of Iran's Supreme Leader has triggered severe retaliatory strikes and the closure of the Strait of Hormuz, halting shipping and threatening oil markets.

WHAT: Iran closed the Strait of Hormuz and attacked regional targets, halting vital oil shipments.

WHY: Tehran is retaliating after a joint US and Israeli strike killed Ayatollah Ali Khamenei.

WHAT NEXT: Markets brace for $100 oil as Gulf producers test alternative overland pipeline routes.

The assassination of Iran’s Supreme Leader Ayatollah Ali Khamenei in a joint US-Israeli air offensive has triggered a severe regional escalation, effectively severing global energy arteries.

Following Tehran’s retaliatory strikes and a declaration by the Islamic Revolutionary Guard Corps (IRGC) that the Strait of Hormuz is closed to international navigation, oil and gas transporters have ceased shipments through the critical maritime chokepoint. The rapidly deteriorating security environment sets the stage for a severe market shock when trading resumes on March 2.

The geopolitical landscape has shifted abruptly. Iran has announced the formation of a three-member transitional council – comprising President Masoud Pezeshkian, Supreme Court Chief Justice Gholam-Hossein Mohseni-Ejei, and Ayatollah Alireza Arafi – to handle state duties. However, the domestic narrative in Tehran has rapidly turned to martyrdom and a fight to the death, significantly elevating the risk of a widespread, protracted regional conflict.

Retaliation

In direct response to the US and Israeli strikes, Iran has utilised ballistic missiles and drones to launch large-scale attacks on US allies and military assets across the Gulf. Authorities in Qatar, Bahrain, Jordan, and Kuwait – all of which host US military bases – reported intercepting inbound projectiles. However, falling debris has caused widespread damage and civilian casualties.

In the UAE, Abu Dhabi authorities confirmed that a drone targeting Zayed International Airport was intercepted; the resulting debris killed one person and injured seven. Meanwhile, a security source told the Oman Observer that the Duqm commercial port was targeted by two drones. One struck a mobile workers’ accommodation, injuring an expatriate worker, while the other fell near fuel tanks without causing material losses. Oman’s government has strongly condemned the targeting, stating it is taking all necessary measures to protect the country’s safety.

Images circulated on social media also appeared to show smoke billowing from a jack-up rig near shore Abu Dhabi, highlighting the level of threat throughout the oil and gas value chain.

Gulf leaders are expected to convene an emergency meeting on March 2 with hopes of de-escalating the situation, which undermines their individual and collective investment attractiveness as well as their economic backbone.

Hormuz halt

The military escalation has directly spilled into commercial shipping lanes. Early on 1 March, the Palau-flagged oil tanker Skylight, reportedly operating under US sanctions, was attacked around 5 nautical miles (9.3km) north of Khasab Port off the coast of Musandam. Oman’s Maritime Security Centre confirmed that the vessel was hit, resulting in injuries to four personnel. All 20 crew members, comprising 15 Indian and five Iranian nationals, were successfully evacuated for medical treatment.

The threat to maritime logistics extends beyond the Gulf. Iran’s regional proxies have actively joined the fray following US or Israeli strikes on bases belonging to the Popular Mobilization Forces in Iraq, which killed at least two members of Kataib Hezbollah. Both Kataib Hezbollah and Yemen’s Houthis have warned they will participate in strikes against US military installations. In addition to personnel, the US Defense Logistics Agency (DLA) maintains critical fuel storage and supply agreements in Bahrain, Masaieed in Qatar, Jebel Ali and Fujairah in the UAE, and Duqm and Salalah in Oman.

Consequently, the shipping industry has effectively paralysed its Middle Eastern operations. Hundreds of vessels dropped anchor over the weekend following the IRGC’s warning. Maersk has announced it is halting all ship transits through the Bab el-Mandeb Strait owing to the rising tensions, opting to reroute vessels around the Cape of Good Hope until further notice.

Oil impact

The physical halt to supplies, combined with the extreme risk of future geopolitical challenges, is expected to drive severe price volatility. Benchmark Brent crude jumped to $73 per barrel on February 27, its highest level since July. However, over-the-counter weekend trading saw prices surge by 8-10% to around $80 per barrel.

When official markets open on March 2, analysts expect prices could rapidly approach $100 per barrel – a $27 premium over close on February 27.

Veteran OPEC analyst Helima Croft from RBC noted that Middle East leaders have previously warned Washington that a war with Iran could push prices past the $100 threshold, a forecast echoed by analysts at Barclays.

Others however, have cautioned that the occurrence of these events over the weekend may give pause to a more tempered reaction.

The International Energy Agency (IEA) has sought to calm the market reaction and is reportedly considering a release of strategic stocks to minimise the price shock. In a post on X, IEA Director Fatih Birol said the IEA “is actively monitoring events in the Middle East and the potential implications for global oil and gas markets and trade flows. Markets have been well supplied to date.” Birol added that he remains in direct contact with regional producer ministries and IEA member governments.

As the crisis unfolds, governments and industry bodies may come under increasing pressure to allow releases from strategic storage, and the latest news is only likely to ramp up interest in such insurance policies, which are regularly overlooked, but the spectre of conflict in eastern Europe and now the Gulf is a reminder of their critical role.

Simultaneously, OPEC+ agreed on March1 to a modest oil output boost of 206,000 barrels per day (bpd) starting in April. Five sources told Reuters the group had debated options ranging from 137,000 bpd to 548,000 bpd. While OPEC+ has historically raised output to cushion disruptions, the current manoeuvre leverages the geopolitical cover provided by the crisis to raise production without risking a corollary drop in prices. According to Reuters sources, Riyadh had already been increasing production and exports in recent weeks in anticipation of US strikes on Iran.

However, the efficacy of this production increase is highly questionable. Croft highlighted that the market impact of any OPEC output rise will be strictly limited due to a lack of actual spare capacity outside of Saudi Arabia. Furthermore, both Riyadh and Abu Dhabi will struggle to export any additional barrels until safe navigation in the Gulf is restored.

Alternatives

Consequently, this crisis will provide the first real test this decade of the overland pipeline routes developed by Gulf states specifically to circumvent the Strait of Hormuz. A June research note by consultancy IGM Energy outlined how years of strategic investment have created a partial insurance policy against the strait’s closure.

Saudi Arabia’s bypass strategy relies on its East-West Pipeline (EWP), which transports crude 1,200 km from the Abqaiq processing hub to export terminals at Yanbu on the Red Sea coast. A recent $250mn upgrade boosted the pipeline’s capacity from 5mn bpd to 7mn bpd, offering Riyadh significant logistical flexibility.

The UAE has similarly fortified its export routes. The Abu Dhabi Crude Oil Pipeline (ADCOP) has been operational since 2012, moving 1.5mn bpd to Fujairah, outside the strait. The Abu Dhabi National Oil Co. (ADNOC) is also advancing a new 1.8mn bpd pipeline from its Jebel Dhanna terminal to Fujairah, expected by 2027, which will eventually double the UAE’s overland capability.

Iran possesses its own alternative via the Goreh-Jask pipeline, launched in 2021 to carry crude from Khuzestan Province to the Gulf of Oman. While possessing a theoretical capacity of 1mn bpd, reports indicate it has practically achieved only 350,000 bpd. That said, buyers for Iranian crude may prove even harder to come by amid the ongoing conflict.

Iraq remains the most structurally exposed major producer, relying almost entirely on Gulf terminals. The potential reopening of the shuttered Kirkuk-Ceyhan pipeline to Turkey, alongside the Kurdistan Regional Government’s parallel conduit, offers a theoretical 1.2mn bpd alternative, though outstanding political and legal disputes must first be resolved.

Collectively, these networks represent a theoretical bypass capacity of over 12mn bpd. While deploying this capacity will place immense strain on Red Sea and Gulf of Oman terminal infrastructure, market observers will be keenly watching vessel movements from Fujairah, Yanbu and Jeddah to see understand how the pipelines are able to counter the closure of Hormuz.

Iran outlook

Given the seismic nature of the killing of Khamenei, the potential permutations for Iran are incredibly varied and wide-ranging. President Trump and the US more broadly are unlikely to have much appetite for a ground offensive in Iran. Instead, he appears to be gambling that decapitating the Islamic Republic’s leadership will force Iran to compromise on its nuclear programme.

However, the transition to new leadership has already begun in Iran, and the IRGC, its omnipresent business interests and the Basij military police remain in place, and will be disinclined to let go of the immeasurable power they hold over the economy.

Meanwhile, the palatability of a potential massive oil shock is a key factor for Trump and the US’ allies ahead of mid-term elections and the apparently endless cost-of-living crisis. That consideration is likely to play into decisions that shape the future of the conflict and its duration.

The Strait of Hormuz is the world’s key oil chokepoint with more than 20% of global crude demand passing through the waterway each day. Over the past decade, it has grown in prominence as Iran has repeatedly threatened to close shipping lanes. Clearly, doing so will result in a spike in oil prices as supplies come under unprecedented pressure. It is broadly expected that such a closure would result in swift military action to remove any physical blockage or weaponry used to target vessels passing through.