The Strait of Hormuz is barely 33 kilometres wide at its narrowest point. Its geography resembles an inverted parabola whose narrowest point lies just short of its apex. This unique arrangement of land and sea has repeatedly proved that geography exercises more power than armies. The Strait of Hormuz was in the limelight, every time tensions flared between Iran and the United States. So why does this narrow ribbon of water connecting the Persian Gulf with the Gulf of Oman and the Arabian Sea yield such enormous power? Why do oil prices climb, insurance premiums surge, financial markets wobble and governments begin contingency planning if Hormuz faces military or political turbulence?
The answer lies in the fact that the Strait of Hormuz has become the economic valve of the globe. Nearly one-fifth of the world’s petroleum consumption and over one-quarter of all seaborne oil trade passes through Hormuz. Qatar’s liquefied natural gas (LNG), together with crude oil from Saudi Arabia, Iraq, Kuwait, the UAE and Iran – all navigate this narrow sea passage before reaching global markets. Even a minor disruption lasting a few days can send tremors across the global economy, with the potential to hike petrol prices in Mumbai, cause inflation in London and reduce the industrial output in Beijing.
History and Geography
The Strait of Hormuz has a long history of holding strategic importance in global commerce. Successive empires jostled for ownership of Hormuz. It was the convergence point of merchant ships carrying spices, silk, horses and textiles and became one of the busiest transit points of international trade. The Portuguese captured Hormuz in 1507 under Afonso de Albuquerque; the Ottomans challenged them in 1552; and an Anglo-Persian alliance expelled the Portuguese in 1622. These battles show that whoever controls Hormuz gains control over one of the world’s most valuable trade corridors.
The latest conflict over the Strait by America wanting to capture Hormuz is thus a history-repeats-itself phenomenon. Geography has bestowed upon Iran a unique strategic advantage in the shape of the Strait of Hormuz. Iran controls almost the entire northern coastline of the Strait and possesses several strategically located islands like Qeshm, Larak and Abu Musa. All these islands overlook the busy shipping lanes making it easy for Iran to regulate them at will. Tehran has repeatedly described the Strait as central to its national security. Naturally, Iranian leadership keep reminding the world that they control the planet’s most important energy corridor.
International Law
At the heart of the legal dispute over the Strait of Hormuz lies the United Nations Convention on the Law of the Sea (UNCLOS adopted in 1994). The United States and Israel (who themselves are not signatory to UNCLOS) assert that the right of transit passage is part of customary international law. Iran takes a different legal view of navigation through the Strait of Hormuz. It argues that ships passing through the Strait are governed by the principle of innocent passage, rather than the broader right of transit passage recognised under UNCLOS.
Under the regime of innocent passage, coastal states enjoy greater authority to regulate maritime traffic. For example, submarines are required to sail on the surface and display their national flag, and foreign military aircraft do not enjoy the automatic right of overflight that accompanies transit passage. Moreover, Article 25(1) of UNCLOS allows a coastal state to take necessary measures to prevent any passage that it considers inconsistent with the principle of innocent passage.
In contrast, the regime of transit passage gives ships and aircraft much greater freedom to pass through international straits with minimal interference from coastal states. Iran’s position is further strengthened by the fact that, although it signed UNCLOS, it has never ratified the Convention. Tehran argues that the concept of transit passage was introduced only under UNCLOS and does not form part of customary international law. Consequently, in Iran’s view, only countries that have ratified UNCLOS are entitled to invoke the right of transit passage.
Iran also maintains that even if transit passage has evolved into customary international law, it is exempt under the doctrine of the persistent objector, having consistently opposed the rule from the outset. Although Iran has signed several international maritime treaties, including the 1958 Convention on the Territorial Sea and the Contiguous Zone, UNCLOS and the 1969 Vienna Convention on the Law of Treaties, it has not ratified any of them.
Free Passage and Commercial Risk
It is a well-known fact that passage through the Panama and Suez Canals is not free. These are artificial waterways built, owned and operated by the governmental authorities of Panama and Egypt respectively who collect transit fees. Ships do not have to pay Iran a toll in the way they pay Panama or Egypt. Although there are reports that Iran did collect transit fees during the conflict just to prove a point and demonstrate the cost of belligerence against Iran.
Once the conflict started, Brent crude prices rose sharply. Commercial shipping companies were forced to divert their vessels, and war-risk insurance premiums rose multiplied. Economists call this a ‘soft closure’. It means there is a situation in which trade slows dramatically without any formal blockade. However, it produces consequences that are similar to a blockade. Some of the grave consequences of any soft closure of the Strait can be gauged by reading the following facts: Over 60% of India’s crude oil imports originate in the Gulf with a substantial share transiting Hormuz. Japan and South Korea face a similar situation. Then, nearly 90% of China’s Gulf oil imports pass through Hormuz.
The Strait and Dollar Hegemony
Crude oil is predominantly traded in US dollars. Consequently, any disruption in Hormuz has implications beyond energy markets. The blockade of the Strait can challenge US dollar hegemony by encouraging countries to trade oil in other currencies.
According to the Petrodollar Theory, the global demand for dollars is sustained because most oil-exporting countries price and sell petroleum in US dollars. Oil-importing nations are forced to hold large dollar reserves to pay for their energy imports.
The Strait of Hormuz crisis showed how dollar-based oil trade is vulnerable to disruptions that endangers the economy of oil-importing countries by inflating their Current Account Deficits which has a ripple effect on other macroeconomic parameters. Hence these countries may increasingly settle oil transactions in alternative currencies such as the Chinese yuan or through bilateral local-currency arrangements.
Such trends will accelerate de-dollarisation and challenge the dollar hegemony. According to the Hegemonic Stability Theory, the dominance of the US dollar depends upon America’s ability to guarantee and secure global trade routes. That ability was exposed by Iran to be an ‘inability’ to protect the interests of its allies and friends. Iran has fired the first salvo to dismantle the unjust ‘dollar hegemony’. Hopefully, the world will soon move towards a more balanced and multipolar international monetary system.