Hormuz Crisis Changes The Structure Of Middle East Oil Sales

The resumption of tit-for-tat attacks between the US and Iran has eroded market confidence in a normalization of flows through the Strait of Hormuz (SoH). Geopolitically, the biggest question remains the most consequential: who will gain control over the future of the Strait of Hormuz? For now, the ongoing stalemate is keeping markets on edge: Iran sees upcoming US elections as its window to maximize leverage and set the future boundary conditions for navigation via the SoH; Israel’s maximalist goals remain unfulfilled; and the global economy is confronting its worst oil products crisis in history, with cracks now at record levels – a reminder that the SoH crisis is as much a products problem as a crude one.

Regardless of how the geopolitical endgame unfolds, a return to the pre-war system for crude sales and pricing looks remote. Confidence in the stability of flows through the SoH lay at the heart of the pre-war mechanisms but has now been shattered.

For now, loading risk has ushered in temporary arrangements such as shuttle sales and STS deliveries in the Gulf of Oman. Hedging strategies have become more difficult to execute as mismatches between trading and loading dates have added to the chaos.

The steady erosion of the region’s FOB (Free on Board) sales model now looks complete, with or without a clear resolution in the SoH. While events remain in flux, what can we say about the future of the Middle East crude trading system?

THE DEATH OF FOB

Geopolitically, the battle for physical control over the SoH continues. Since the breakdown of the mid-June US-Iran MoU, Iran has attacked vessels traversing Omani waters, strikes have been levelled against Kuwait, Bahrain, Qatar and Oman and in a further sign of escalation, UAE “shuttle” vessels have been targeted.

While the future trajectory of events remains unclear, a return to the Middle East’s pre-war pricing cycle looks highly unlikely.

Pre-war, a typical cycle would first involve Saudi Aramco issuing its official selling prices (OSP) early in the month for month-ahead loading, with the differential guided by shifts in the shape of the Dubai forward curve, supply and demand fundamentals, quality spreads and refining margins. Aramco’s formula pricing was almost always the guide for others, dictating the formula prices of key producers such as Iraq. This ensured that term cargoes were not mispriced and equity lifters were not left in a pricing rut. Uninterruptable scheduling and loading underpinned the system, allowing one producer to look at another to assess fair value.

Also underpinning the OSP formula pricing model were shifts in the reference spot market for cargoes loading two months ahead. The playground for this activity has typically been the Platts Dubai window, where deliverable grades are the market’s “bullets” to defend fair value and maintain management of hedging and paper positions held in liquid derivative markets. Mismatches in trading and loading dates were also rare: a cargo priced today would load two months ahead, ensuring no disruption to the linkages between physical and paper markets.

Outside the window, physical spot cargoes trading in chains in bilateral OTC (over the counter) contracts would be bought and sold multiple times before reaching final delivery.

While the above is a simplification of the typical pricing cycle, loading and scheduling predictability was at the heart of the system. Trust was paramount so that faulty hedges would not occur and if they did, they were infrequent.

With the SoH crisis ultimately a loading crisis, questions are being raised over whether the region’s FOB model is now coming undone and whether adaptive measures evolve into structural features of a new sales and pricing landscape.

Reflecting the new trading realities inside the SoH remains the shuttle model, most actively being used by Adnoc.

Since June, Adnoc has sold around 75-80mn barrels of offshore crude via tenders, with most sales for prompt delivery. Underpinning Adnoc’s sales velocity has been its use of vessels either owned or managed by Adnoc to “shuttle” cargoes from offshore terminals to STS locations such as Fujairah (MEES, 3 July).

Beyond vessels it already owns, Adnoc’s time-charter deals with shipping heavyweights such as Sinokor have added a layer of delivery optionality that has helped support sales of offshore crude, previously held in inventory as unsold crude originally intended for term lifters at the height of the crisis. While recent vessel attacks against the UAE by Iran continue to keep the market guessing on whether Adnoc’s “shuttle” model is sustainable, the temporary arrangement has helped the UAE’s upstream recovery, allowing Adnoc’s term lifters to play “catch-up” with cargoes they couldn’t collect at the height of the conflict in April-May.

Market sources have noted that under Adnoc’s term contract with buyers, if a lifter can’t take delivery, Adnoc has the right to resell the cargo in the next delivery cycle on a spot basis. The term buyer then must compensate Adnoc for the difference if the spot cargo sells for less than the term price offered during the originally scheduled loading month. For example, a May-loading Upper Zakum cargo would have fetched around $110/B. If that cargo was sold in June against Dubai, the difference would amount to around $30/B. Critically, this clause is waived if that same term buyer participates in the tender, offsetting their liability to Adnoc. The net effect of this has been to create a rush by Adnoc’s term buyers to offset their exposure and play “catch-up” in taking delivery of their volumes. Alongside producers wanting to recoup lost cash flow from the war, this creates an incentive to sell cargoes on a prompter basis.

Beyond Adnoc’s “shuttle service” helping drive a recovery in UAE crude production (MEES, 10 July), its shipping flexibility is also providing some trading opportunities inside the SoH. Iraq provides a case in point.

With no tankers of its own, Iraq has had to provide aggressive discounts to its OSP to shift cargoes. Interestingly, a 2mn barrel July-loading Basrah Medium cargo was heard to have sold to Adnoc Trading at a discount of $14/B to the OSP and later sold to Formosa at a $3/B premium to Dubai via Fujairah STS. Iraq’s FOB pricing power is being further eroded by the risk-aversion of term and equity lifters to load from Basrah Oil Terminal (BOT). Despite seeing some recovery in its upstream production in June, ongoing reluctance by Iraq’s term and equity customers to lift is creating an on-off feedback loop which slows its production recovery, particularly given wellbore complexities, storage constraints and the country’s lack of infrastructural flex.

This has created major opportunities for a select number of trading houses ready to exploit the FOB pure play model: market sources have noted that Adnoc Trading is using excess tonnage to negotiate discounts with Iraq, joined by players such as Mercuria, Totsa and Vitol – the latter an early pioneer of the shuttle service to move Basrah cargoes to STS locations at the height of the SoH crisis.

STS AND DELIVERED: A PERMANENT FIXTURE?

Although Adnoc will see the STS model as temporary as the UAE is on target to expand export capacity via Fujairah to 3.3mn b/d by mid-2027 (MEES, 27 March), the STS model could become a more structural feature of crude sales for FOB pure play producers.

Even under an optimistic scenario whereby there is a timely resolution to the crisis, a discrepancy between worldscale values for freight rates inside versus outside the SoH will likely persist. The compliance teams of shipping arms of IOCs who hold equity or term cargoes in the region will also take time to adjust. As a result, STS could become the measure of risk transfer going forward. Despite the UAE being on track to expand pipeline capacity to Fujairah by mid-2027, traders are circulating ideas suggesting that Platts – the custodian of the Dubai benchmark – should include a CIF (Cost, Insurance and Freight) Upper Zakum price based on STS Fujairah in the benchmark assessment, even if only as a precautionary measure. A freight adjustment factor (FAF) can be applied to the grade and converted to a FOB price, as occurs with WTI Midland in the Brent benchmark.

Alongside STS, the other big question mark for the region’s oil sales remains the future role of delivered pricing.

Adnoc’s shipping arm, Adnoc L&S, Saudi Arabia’s Bahri and Kuwait’s KOTC are all expanding their tanker tonnage. Bahri has expanded its lease of VLCCs, and there are rumours that it has ambitions to purchase more VLCCs this year. This falls under Saudi Arabia’s wider strategy of increasing resilience alongside expanding in-kingdom crude and product storage facilities, upgrading the East-West pipeline to allow for greater grade flexibility and export terminal expansions.

Aramco’s volume of delivered spot sales has grown in recent weeks. In early July, Aramco sold a 2mn barrel cargo of Arab Medium to Shenghong on a delivered basis. Likewise, Chinese term customers nominated record low volumes of Aramco crude for August-loading (sold on a FOB basis) as buyers such as Unipec and Rongsheng preferred delivered spot cargoes.

While delivered spot sales and tenders are likely to grow in importance in the future Middle East crude market, it remains doubtful that pricing can move so swiftly to a delivered model – FOB physical prices mirror the Dubai curve and allow for efficient hedging practices. For freight, forward liquidity remains an issue, raising questions as to how a producer such as Aramco can hedge its freight exposure for delivered pricing. Instead, bilateral negotiations where time charter teams negotiate prices directly will likely become the norm – until a more mature ecosystem around freight derivative pricing emerges.

REBUILDING TRUST

Regardless of where events move next in the Middle East, the overarching theme for producers remains constant: resilience and rebuilding trust. The SoH crisis has already triggered lawsuits, tensions between equity lifters and producers and court battles between trading houses with other counterparties and exchanges. The ricochet effect of such a massive loading shock is not simply a loss of physical cargoes but also the multi-billion-dollar paper positions which underpin them.

In the UAE, for example, at the height of the crisis in April and May, Adnoc cut its equity lifters. The impact was not only a loss of physical volume but also paper losses as Adnoc cargoes are allocated on an OSP basis and hedged using Dubai swaps which reached record levels. The cascading effects have been severe.

Similar tensions have also surfaced in Iraq. For example, at the height of the crisis in May, Somo offered its term lifters a $33/B discount v OSP for May-loading cargoes but for equity lifters, the Basrah Medium price was Somo’s official May-loading OSP set at +$17.3/B – a divergence driven by Iraq’s need to book cash immediately and restore cash flows amid the crisis. As a result, equity lifters got pushed to the back of the queue. A similar situation happened in June where the discount for Basrah Medium was $20/B v OSP for term customers, but equity lifters were given the OSP of +$4.3/B. Only in July was the situation rectified after significant complaints by equity lifters.

Going forward, rebuilding the delicate balance between term and equity customers will be key. Already, some signs appear to be pointing in that direction.

As part of the UAE’s ambitions to expand production capacity in 2027, Adnoc has held meetings with its term customers to negotiate volumes. As part of that exercise, requests were made to shift OSP pricing formulae for offshore grades back to a Dubai basis, instead of being priced as a differential to IFAD Murban (MEES, 3 July). Why was this a rebuilding trust measure? Part of the reason rests with the Upper Zakum differential to IFAD Murban not always being aligned with Dubai M1-M3 structure, which led to accusations that the PnL (profit and loss) of 15 cargoes were mispricing over 200 cargoes. Tensions will always exist between term customers and producers over OSP pricing but in a more volatile Middle East crude landscape – especially one where hedging has become more difficult – reducing basis and loading risk has become a key source of re-establishing trust. The episode also highlights the challenges of a producer trying to be all things at once: a producer, trader, and benchmark provider.

Ultimately, the future geopolitical configuration of the Middle East is in flux. A neat outcome looks unlikely and regardless of whether another temporary ceasefire emerges, loading risk has become a structural reality for the region. Delivery optionality and infrastructural flexibility are the new metrics of competitiveness in the region. Aramco is advancing plans to expand Yanbu loading, and Adnoc is on track to expand Fujairah pipeline capacity. While Iraq has discussed new pipelines from Basrah to Haditha and on to export terminals in Syria or elsewhere, its historical track record on execution has been far from stellar.

In this new trading reality, optimizing tanker tonnage is no longer a luxury but a necessity. In this multi-speed Middle East, producers such as Iraq can no longer take their cues on pricing from Saudi Arabia as FOB loading risk is operating from different baselines. The region also becomes more opaque going forward: AIS signalling shuts down, tenders grow in importance and bilateral negotiations around freight become the norm – especially as delivered pricing grows in importance.

* Ahmed Mehdi is Managing Director of Renaissance Energy Advisors (REA)