Kemp: Yemen Fuels Short-Covering Rally in Oil

Air strikes by Saudi Arabia and its allies in Yemen have sparked a modest rise in oil prices of $3 per barrel, even though Yemen plays a marginal role in the global oil market.

Yemen produces just 130,000 barrels per day, according to the U.S. Energy Information Administration (EIA), about 0.1 percent of global production and the same as Italy or Kansas.

The country shares a long border with southwest Saudi Arabia but violence in that area poses no threat to the main Saudi oilfields, which are concentrated in the northeast of the kingdom.

More significantly, Yemen forms one coastline of the Bab el-Mandeb Strait, which connects the Red Sea with the Gulf of Aden and the Arabian Sea.

On average almost 4 million barrels of oil pass through the Bab el-Mandeb Strait every day en route from the main Gulf oilfields to refineries in the Mediterranean and Europe.

Like the Strait of Hormuz and the Strait of Malacca, Bab el-Mandeb has been identified by the EIA as one of the potential "chokepoints" in the global oil market.

If the strait were closed or became unsafe for transit, tankers would have to re-route around the southern tip of Africa, adding thousands of kilometres and weeks of extra journey time.

But unlike the Strait of Hormuz (17 million barrels per day) or the Strait of Malacca (15 million barrels per day), the volume of oil passing through Bab el-Mandeb is relatively small and there are alternatives, albeit inconvenient ones.

Iranian naval officials have in the past hinted they would seek to close the Strait of Hormuz in the event of an armed confrontation with the United States.

In reality, there are doubts about whether the Iranian navy and Revolutionary Guards could keep the strait blocked against the might of the U.S. Fifth Fleet, based in Bahrain.

There is no suggestion any of the sides to the conflict in Yemen have access to the modern weaponry needed to pose a serious threat to shipping in the Bab el-Mandeb.

The prospect of disruption to either oil production or supply lines as a result of the warfare in Yemen is therefore remote.

Some analysts remain concerned about the prospect for escalation dragging in bigger regional powers and oil producers, given that Saudi Arabia and Iran are backing opposite sides in the conflict.

But Yemen is a peripheral concern for Iran, which has more vital interests at stake in the nuclear negotiations and fighting Islamic State in Iraq.

Iran may offer encouragement, cash and arms to the Houthis in Yemen, but it has no reason to risk a full military conflict with Saudi Arabia and its allies over such a marginal issue.

There is a long history of outside powers - including Saudi Arabia, Egypt, the United States and the Soviet Union - backing different tribes in Yemen's numerous civil wars and insurrections, but the conflicts have all been contained more or less within the country's borders.

The jump in oil prices over the past 24 hours therefore says more about the positioning of major financial players in the oil markets than the risk to global oil supplies.

Prior to the onset of the air strikes, hedge funds and other money managers had amassed the largest short positions in oil-linked derivative contracts on record.

As recently as March 17, hedge funds held futures and options contracts equivalent to 209 million barrels of oil linked to U.S. crude prices and another 95 million barrels linked to Brent prices, according to regulators, betting on a further fall in oil prices.

Many bearish hedge fund managers and oil analysts were convinced the rapid rise in crude oil stocks, especially in the United States, would cause a further fall in prices. But when the market is stretched in this way, either short or long, it is very vulnerable to any unexpected news in the other direction.

In this instance, prices for Brent and U.S. crude began rising gradually on March 18, as the weight of selling petered out and hedge funds began to cover some of their positions. Confirmation that Saudi Arabia had launched air strikes in Yemen simply accelerated the existing short-covering trend.

By John Kemp