Why is the Strait of Hormuz so important for Oil, and what happens if Iran blocks it?

As the Israel-Iran conflict reaches new heights, an old threat is coming back to haunt the markets: that of the closure of the Strait of Hormuz. This narrow arm of the sea in the Persian Gulf, wedged between Iran to the north and the United Arab Emirates and Oman to the south, is much more than a simple sea passage. It is the aorta of the world's energy economy. And against a backdrop of air strikes, military threats and diplomatic uncertainties, its vulnerability could become the trigger for a global Oil shock.

But why is the Strait of Hormuz so crucial? How would Oil prices behave if Iran decided to block it? Are the markets ready for such a shock? And is this dreaded scenario really plausible, or is it simply a geopolitical deterrent?

The Strait of Hormuz, a vital artery for world Oil

According to the International Energy Agency (IEA), the Strait of Hormuz is the point of passage for almost 20 million barrels of Oil a day, or around 30% of the world's Oil transported by sea. It also handles 20% of the world's Liquefied Natural Gas (LNG) trade, mainly from Qatar.

This corridor, only 33 kilometers wide at its narrowest, concentrates the energy exports of key Persian Gulf countries such as Saudi Arabia, the Emirates, Iraq, Kuwait and, of course, Iran. It is also the transit point for almost all the world's emergency production capacity, making this strait a critical strategic node for energy price stability.

Source: EnergyNow.

"The majority of the world's spare production capacity is located in the Gulf. A closure of the Strait would make these volumes inaccessible", notes the IEA, according to a EuroNews report.

Adding that the US Energy Information Administration (EIA) calls it the "world's most important Oil chokepoint," underlining the strategic importance of the passage that links the Persian Gulf with the Gulf of Oman and the Arabian Sea.

Is a complete blockade by Iran possible?

The recent Israel-Iran conflict has sparked fears of a closure of the Strait of Hormuz. Technically, blocking the Strait is no simple matter. Most of the waterway lies in international or Omani waters, and the US military presence in the region, notably the 5th Fleet in Bahrain, acts as a powerful deterrent. But this doesn't stop Iran from disrupting navigation via drone attacks, naval mines or targeted interceptions.

Many experts believe that a complete closure would be a last resort in the event of open conflict with the United States. Indeed, Iran itself depends on the Strait to export its Oil, mainly to China. Closing Hormuz would mean cutting off a vital source of revenue for Tehran.

"There is no net benefit for Iran in closing the Strait. It would hurt its own exports to China, its biggest customer," notes CNBC.

CNBC also quoted Anas Alhajji, managing partner at Energy Outlook Advisors: "Their friends will suffer more than their enemies... So it's very hard to see that happening," adding that disrupting the channel could be more of a bane than a boon for Tehran, given how most of Iran's daily consumption goods come via that route. 

"It's not in their interest to cause problems because they will suffer first," he said.

Secondly, a shutdown would almost inevitably trigger a military response from the United States. As Bloomberg points out, "the Strait has been threatened before, but never closed, even at the height of the Iran-Iraq war in the 1980s".

For RBC Capital Markets, a complete blockade is "highly unlikely", but "targeted attacks on tankers, mine-laying, or disruption by drones or missiles are methods well within the Iranian operational spectrum."

Why the threat of a blockade is shaking Oil markets

Iran has repeatedly threatened to block the Strait of Hormuz, notably during crises with the United States in 2011, 2018 and 2020. So far, these threats have never materialized into a total closure, but the mere mention of them is enough to provoke crude Oil price rises.

According to several banks, a complete closure of the Strait could cause crude Oil prices to soar above $120 to $150 a barrel, or even more if the conflict is prolonged.

For Deutsche Bank, "the scenario of a total closure of the Strait, causing an interruption of 21 million barrels a day for two months, could push Oil to over $120 a barrel, or even beyond if global supplies are permanently disrupted."

In a note from Rabobank, analysts even mention a spike towards $150 a barrel, recalling that in 2022, after Russia invaded Ukraine, the Brent briefly touched $139. But the difference here is major: "Gulf Oil is geographically concentrated and trapped in a single access point," they note. "That's not hyperbole, it's fact."

TD Securities, meanwhile, points out that "the Oil market is currently in a situation of oversupply, but if the Straits are blocked, even temporarily, no production capacity - neither from OPEC nor the United States - can immediately compensate for a shortfall of 17 to 20 million barrels/day."

Consequences of the shutdown of the Strait of Hormuz

A blockade of the Strait would have cascading consequences:

• Energy inflation: Crude Oil and Gas prices would soar, affecting household bills, industrial costs and overall inflation. An Oil price surge above $120 would trigger "a drop in global growth, similar to 1973, 1990 or 2022", notes Deutsche Bank.
• Energy shock in Europe and Asia: Europe is still largely dependent on Qatari LNG, which transits through Hormuz. And for Asia, "the closure of the Strait would be a major blow, particularly for China, India and South Korea", according to ING.
• Geopolitical crisis: The EU, NATO and the major Asian maritime powers would be forced to intervene. "This would be a situation where energy and military interests overlap dangerously," warns an expert quoted by EuroNews.
• Disruption of supply chains: Beyond energy, Hormuz is also a key axis of global maritime trade. A prolonged closure would increase marine insurance premiums, impacting the prices of imported goods, and delaying many imports.

What markets are anticipating today

Brent Crude Oil prices. Source: FXStreet

Despite the military Israel-Iran conflict, markets remain relatively calm. The price of Brent crude is hovering under $74, and WTI Oil under $72, well below critical levels.

Why is this so? Because the central scenario remains that of a limited escalation, with no major disruption and damage to Oil infrastructures or closure of Hormuz.

But this market restraint masks extreme nervousness. The mere mention of the word "Hormuz" in Iranian statements is enough to trigger immediate Crude Oil price rises. This shows the extent to which the Persian Gulf has become the emotional barometer of the energy market.

For Danske Bank, this reflects the fact that "the market is not (yet) pricing a major disruption. Iran's Oil infrastructure has not been targeted, and Hormuz remains open".

But TD Securities warns that "war dynamics are inherently unpredictable". Should Iran decide to strike Saudi, Emirati or Qatari facilities, prices could jump to $130 or more, as it occurred in March 2022.

A structural risk difficult to circumvent

The Strait of Hormuz is both a vital passage point and a permanent point of tension. As long as the world depends on Oil from the Persian Gulf, its security will remain a major geostrategic concern. If Iran were to cross the red line, the consequences would not be limited to barrels of Oil, but the global economic balance could be shaken.

Even without a shutdown, the risk is enough to maintain a geopolitical premium on Oil prices. In this sense, Hormuz is more than a Strait, it's a sword of Damocles hanging over world markets.