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Hormuz threats lose their sting

As Gulf states progress bypass projects, time runs down on Iran’s sabre-rattling

The Strait of Hormuz is the world’s key oil chokepoint, with more than 20pc of global crude demand passing through the waterway each day. Repeated threats by Iran over the past decade to close its shipping lanes have thus proven headline-grabbing.

Should it risk doing so, the likely result would be a material spike in oil prices as Mid-East Gulf supply was constrained. The logical next step would be swift intervention, almost certainly of a military nature, to remove any blockage if possible.

While the threat has somewhat subsided over the last few years, last month Iran’s deputy commander of political affairs, General Yadollah Javani, warned that, if there was a need to close the strait, Iran is “undoubtedly capable of doing so”. The thinly veiled threat came as Javani discussed Iran’s retaliation for the killing of General Qassem Soleimani, head of the Islamic Revolutionary Guard Corps’ elite Quds force, by a US airstrike in January.

Given the regional geography, there are limited options for bypassing Hormuz. But Gulf oil producers aware of the threat that overdependence on the sea route poses have been moving to increase their alternatives. Pipelines and other alternative route-to-market initiatives have made progress in recent months.

Saudi Arabia

Iran’s regional nemesis Saudi Arabia has the most to lose from the potential closure of Hormuz. With the majority of its 202bn bl of crude reserves located in its Eastern Province, most of its exports are loaded at the nearby Ras Tanura and Ju’aymah terminals on the Gulf coast. It has placed significant focus on a Red Sea export alternatives in recent years, with a 2018 expansion increasing the Yanbu terminal’s loading capacity to 6.6mn bl/d.

>20pc – World crude demand passing via Hormuz every day

In its 2019 Annual Report, Saudi Aramco alluded to the risks of exporting through the Strait of Hormuz, and, with this in mind, it has increased the capacity of the East-West pipeline system which runs from the major processing hub of Abqaiq to Yanbu’. Its flows averaged 2.1mn bl/d in 2018 and 2019.

Aramco is clearly, though, keen that the system could be used at much higher rates if necessary. Having reached a “temporary mechanical capacity increase” from 5mn bl/d to 7mn bl/d through the “interim conversion of NGL pipelines and use of reducing agents”, Aramco is understood to be in the process of making this increase permanent.

The company also holds a 15pc equity interest in the Arab Petroleum Pipeline joint venture, which operates the Sumed pipeline running from the Red Sea through Egypt to the Mediterranean and acting as an alternative to the Suez Canal.

UAE

A recent deal signed with Israel offers a similar route to the UAE. Following normalisation of relations between Abu Dhabi and Israel, an agreement was announced to allow the UAE to utilise the 254km Eilat-Ashkelon Pipeline to move crude from the Red Sea to the Mediterranean at a rate of up to 600,000bl/d. The recently restyled Europe Asia Pipeline Co. has also been in talks about extending Eilat-Ashkelon 700km to Yanbu, although such a move would require a similar breakthrough in Saudi-Israel relations.

The UAE already has the Abu Dhabi Crude Oil Pipeline (Adcop), which transports oil from processing facilities at Habshan in its Western Region to the eastern emirate of Fujairah on the Sea of Oman, south of Hormuz. The 400km conduit was completed in 2014 and has a capacity of 1.5mn bl/d for dispatch from Fujairah’s export terminal, where NOC Adnoc recently expanded its share of 8mn bl of storage capacity through acquiring a 10pc stake in logistics firm VTTI.

The Israeli pipeline deal is not of sufficient size to materially dent the UAE’s reliance on Hormuz. But, in combination with Fujairah expansion, it offers faster and more cost-effective options for oil exports heading west.

Iraq

To the north, Iraq is all but landlocked, having only 58km of coastline on which the Al-Basrah and Khor Al-Amaya oil terminals are located. With its pipeline export infrastructure falling into disrepair, Baghdad has been reliant on these terminals to export more than 90pc of the crude it sells, with the remainder flowing through Kurdish-controlled infrastructure to a metering station at Fishkhabour on the border with Turkey.

The federal government’s existing Kirkuk-Ceyhan pipeline consists of two strings with an original combined nameplate capacity of 1.6mn bl/d—a wider 46-inch pipe capable of carrying 1.1mn bl/d and a narrower 40-inch line that can move 500,000bl/d. But, following years of sabotage and disrepair, Baghdad appears to need to use spare capacity in the Erbil-controlled route to move crude produced at Kirkuk fields.

“[Iran is] undoubtedly capable [of closing the strait]” Javani, Iranian deputy commander of political affairs

Iraq has been looking to ease its reliance on its Gulf terminals since the mid-1980s. Talks have revolved around the rehabilitation of two further disused pipelines—the Kirkuk-Banias line through Syria and the Iraq Saudi Arabia pipeline, which follows a similar path to the East-West conduit heading towards the Red Sea from near Riyadh.

But, given political obstacles to these rehabilitations, a more likely option may be a 1mn bl/d line linking Basra to the Jordanian Red Sea port of Aqaba. This was first tabled as far back as 1984 and has recurred in various forms. A pared-back version was recently given the go-ahead by Amman and Baghdad.

It envisages a $5bn two-phase project consisting of a 700km pipeline, with a capacity of 2.25mn bl/d, from Rumaila to the K3 pumping station at Haditha in northern Iraq, which is connected by pipeline to the Baiji refinery and northern Iraq. A 900km line would run from Haditha and Aqaba capable of moving of 1mn bl/d in a second phase.

The project’s momentum appeared to be building when Iraq resumed trucked exports to Jordan. But ongoing Iraqi civil unrest and the impact of Covid-19 have seen a delay in bidding, and further hold-ups may be anticipated given the project’s challenging economics and logistics.

But a strengthening of Iraqi and Jordanian government ties does provide some optimism for its eventual realisation. Such sentiment was boosted in September when Jordan agreed to supply Iraq with 1GWh/yr of electricity and to connect their respective power grids.

Iran

Despite being the region’s only actor to threaten Hormuz closures, Iran would also be severely hobbled by any disruptions given that the Kharg Island terminal inside the Gulf accounts for 90pc of its oil exports.

It too has been developing alternatives. Work on the first phase of the 1,000km Goreh-Jask line is now more than 75pc complete and is on schedule to be finished by March 2021.

It will allow 300,000bl/d of crude to be transported from the West Karoun oilfields to the port of Jask, which lies on the Gulf of Oman and—following its inauguration early this year by President Hassan Rouhani—is earmarked to become a key Iranian oil export hub. A subsequent phase will increase throughput to 1mn bl/d and storage capacity to 10mn bl.

6.6mn bl/d – Export capacity at Yanbu

Iran will likely continue bandying around threats—both directly to its neighbours and to an oil price-sensitive wider world—for a while yet. However, as capacity grows in alternatives circumventing the chokepoint, this threat will hold progressively less weight.

Given the speed at which the Goreh-Jask line is being constructed, Tehran may be looking to create a window where it could actually go through with its threat while it still damages its enemies but is itself relatively unaffected. With its current exports running at less than 2mn bl/d, once the Jask terminal and pipeline infrastructure is operational, Iran will have comparatively little to lose, at least from an oil standpoint.

Even if it never consummated the threat, the increased bargaining power of such a position would considerably skew the Gulf’s political balance. It would also pose a substantial headache for a relatively new administration in the White House.

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