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Strait of Hormuz: the world's LNG choke point

How, if at all, asks Kwok W Wan, would shutting the Strait of Hormuz affect European gas and Asian LNG prices?

Iran's threat to shut the Strait of Hormuz is a reminder to European gas and Asian liquefied natural gas (LNG) buyers of how vulnerable Qatar is to Middle East geopolitics.

And while the immediate effect would likely be felt on UK gas prices, the damage to Qatar’s reputation could persuade Asian customers to hold off from signing long-term contracts and turn to upcoming Australian LNG-export projects instead.

Iran and the US have been upping the rhetoric over Hormuz during the past two weeks. Iran threatened to shut the crucial waterway after the EU and US announced plans to impose sanctions on the country’s oil exports, which in turn was a response to Iran’s failure to negotiate over its nuclear programme.

Two US aircraft carriers left Dubai last week after Iran test fired medium-range missiles during a training exercise. Both sides have delivered verbal pot-shots regarding the use of military action to defend or close the Strait of Hormuz.

But as well as cutting the route for oil tankers, shutting Hormuz would choke off Qatar’s 77 million tonnes a year (t/y) of LNG production capacity, which accounts for 30% of the global LNG market. UK gas supplies would be first to take a hit, while Asian buyers may start to doubt the security of their supplies from the Middle East.

Key dependence

“The key dependence is that nearly 85% of the UK’s LNG imports came from Qatar last year, compared with 15% for Japan,” said Claire Wright, senior market analyst at Lloyds List Intelligence (see Figure 1). The shipping consultancy calculates Qatar exported 15.66 million tonnes to the UK from December 2010 to November 2011, compared with 11.7 million tonnes to Japan – the world’s largest LNG importer. “Over 1,000 LNG tankers loaded in Qatar or the UAE [from the 5.6 million t/y Adgas facility] over the 12 months to end-November 2011. Except for a handful – no more than 15 discharged in Kuwait – these all passed through the Strait of Hormuz, on both their ballast and laden voyages,” she added.

The latest UK government figures show that LNG imports for the first three quarters of 2011 where higher than pipeline imports, with LNG deliveries jumping by 50.4% compared with the same period in 2010.

LNG prices would also be forced up in Asia, where Japan has increased its import volumes to compensate for the nuclear reactor outages following last year’s earthquake and tsunami, and subsequent meltdown at the Fukushima-Daiichi plant. Japan is likely to import over 80 million t/y of LNG this year, and the closing of Hormuz would remove around 15% of its LNG supply.

Security threat

As well as the immediate effect of cutting off Middle East LNG supply to the world, the closure of Hormuz may also wreck Qatar’s plans to sign long-term contracts with Asian customers. The two largest LNG importers in the world, Japan and South Korea, could sign more deals with Australia instead, despite concerns over LNG project costs and delays.

“In the longer term, established Asian LNG buyers could be concerned with security of supply from the Middle East, making them turn to Australian projects, potentially supporting the development of new Australian LNG capacity,” said David Ledesma, research fellow at the Oxford Institute for Energy Studies.

Australia could overtake Qatar as the world’s largest LNG producer in the next decade, but projects have been blighted with delays and escalating costs. Meanwhile, Qatar is determined to secure sales by signing long-term LNG supply contracts rather than relying on sales in the spot market

Ledesma added that if Iran blocks the Strait of Hormuz, it could also anger Qatar into breaking its drilling moratorium at the North Field, which it shares with Iran (the Islamic republic calls its section of the field South Pars). Qatar stopped developing the North Field in 2005, because of concerns about depleting the field’s resources too quickly and reducing the lifespan of the reservoir – the largest gasfield in the world.

Low risk

But, unlike the oil market, where North Sea Brent rose after the EU confirmed it had agreed in principle to impose oil sanctions on Iran, UK gas and Asian LNG prices have not seen much reaction to Iran’s muscle flexing over Hormuz – the market does not believe the strait could be shut for any significant amount of time.

“I don’t think it will have any impact on LNG,” said Tony Regan, principle LNG analyst at Tri-Zen. “Closure would have a huge impact, as about 30% of global LNG supply comes through the Strait – but buyers don’t believe the risk is high enough to do anything about it.” LNG traders and brokers agreed that the US Navy would step if Iran was to attempt to shut the Strait and that the Iranian threats were most likely empty.

In the UK gas market – Europe’s most liquid gas hub – traders are also relaxed about any potential cut in LNG supply, citing low heating demand, because of a mild winter, and high gas-storage levels for subdued UK gas prices. “A Fukushima type event, a Strait closure that curtails supply, would be needed to move prices up,” said one UK gas trader.

Military action

But could Iran realistically shut the Strait of Hormuz – 21 miles wide at its narrowest point, comprising a two-mile-wide shipping lane – with a significant US Navy presence in nearby Bahrain, home to the US Fifth Fleet?

“Iran could possibly close the Strait for a number of days, up to weeks, using a combination of small boats, mines and missiles, but probably no longer than that, and its navy and missile sites would then be annihilated by the US,” said Robin Mills, head of consulting at Manaar Energy.  “It would be difficult to lay a continuous belt of mines without being detected. More likely, Iran could cause trouble with random mines, enough to scare off some ships and put up insurance premiums, but not stop traffic altogether,” he added.

Shutting the Strait of Hormuz would also be a last resort, as it would close down Iran’s own oil-export route, and the country relies on crude sales for around 50% of its economy.“It’s the suicide card for Iran if they attempted it. They have far more to lose by blocking the Strait than the other [Mideast Gulf] states,” said Tri-Zen’s Regan.

Figure 1 - Top-five Qatari LNG importers
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