The prospect of sanctions against the Iranian regime and the potential repercussions for the oil industry have been well reported in the mainstream media, with Tehran warning that it is prepared to throttle supplies through a key shipping artery. The conflict also poses a sizeable risk to the natural gas sector, but this has attracted nowhere near the same level of coverage. Shutting off the Strait of Hormuz, as Iran has threatened, would deprive the UK of by far its most important source of liquefied natural gas (LNG), which would leave a supply gap and trigger a stratospheric rise in prices.
Faced with tough US financial restrictions and an impending European Union ban on Iranian crude, officials in Tehran have repeatedly cautioned that the country may retaliate by blockading the slender waterway that links the Persian Gulf with the Arabian Sea. At its narrowest the strait is 34km across, with a shipping lane of only 3km in width, and it is the transit route for around one-fifth of oil traded worldwide. Crucially, though, it is also the outlet for 30 per cent of global LNG traffic, making it the main chokepoint for seaborne cargoes of the super-cooled fuel as well.
LNG met 15 per cent of Britain’s gas demand in the past five months, but at times it has made up much more. Last summer, it contributed almost one-third. This has coincided with a massive increase in production by Qatar, whose cargoes make up the lion’s share of our LNG intake (85 per cent in 2011).
Situated in the Persian Gulf, Qatar relies exclusively on the Strait of Hormuz for safe passage of its LNG tanker fleet to its European and Asian clientele. Aside from a handful of deliveries to nearby Kuwait, all shipments must pass through this narrow waterway. So as well as cutting off the route for oil tankers, shutting Hormuz would effectively choke off Qatar’s 77 million tonnes of LNG capacity a year, leaving import-reliant nations such as the UK short of supplies.
Should Tehran make good on its threat, prices at the National Balancing Point – the UK’s wholesale gas market – would almost certainly soar, as they did in the aftermath of the Japanese earthquake last March, which sparked concerns over LNG diversions to the Far East. As the world’s top importer of LNG, Japan would also feel the pinch, but is less susceptible to an interruption in Qatari output because of its diverse supply portfolio. Even so, Asian LNG prices would be forced up and the need to make Europe competitive would exacerbate the bull-run at the UK gas hub.
Heightened tensions between Iran and the West have given oil traders the jitters, fuelling Brent crude’s recent strength, although little risk premium has been factored into UK gas contracts by comparison, with participants it seems unperturbed by the threat to LNG supplies. The difference between the two is that oil has received support from a variety of other geopolitical factors, notwithstanding the looming EU embargo on Iranian crude, whereas gas fundamentals have remained broadly comfortable, aside from February’s freezing temperatures.
The consensus within the UK gas industry is that Iran is unlikely to shut the Strait of Hormuz and as such traders have shrugged off the risk to LNG imports. This would represent an act of war, plus Iran depends on the waterway to deliver its own oil to buyers in Asia. Outmatched by US naval forces, commentators claim that it would be a desperate and short-lived act of retaliation and the regime would only act on its threat as a last resort.
Tehran is much more likely to antagonise the West by proxy retaliation elsewhere in the Middle East, for instance by inciting violence via affiliate Shia groups in Iraq and providing low-level support to the Taliban insurgency in Afghanistan. The Iranian regime already appears to have stepped up its efforts and stands accused of orchestrating terrorist attacks on Israeli embassy staff around the world through its Lebanese ally Hezbollah. Lawmakers in the country have also threatened to pile the pressure on the eurozone by pre-emptively cutting off oil supplies to the likes of Greece, Spain and Italy before the embargo kicks in this July.
The West may be content to use a combination of sanctions and diplomacy, but Israel has refused to take military intervention off the table. There has been talk within the international community of late that Israel may launch an attack in the spring, targeting Iran’s nuclear facilities before they get too advanced. Keen to wipe out a national security threat and keep Jewish voters on side during an election year, Washington would be loath to condemn the Israeli-led attacks should such events transpire.
So while closing the Strait of Hormuz might seem a self-defeating and last-gasp act of retaliation, it may be something that Iran’s rulers think seriously about if they feel they have been forced into a corner, especially if they lose all the progress they have made in their nuclear programme. As volatile a character as he may be, president Mahmoud Ahmadinejad is predictable in his defiance of the West and no such action, however unfeasible, should be discounted entirely.
Beneath the surface, the threat of Israeli intervention has already begun to have an influence on the energy sector. Having hit a floor in early January, the UK gas market has recently regained a foothold, putting an end to the dramatic sell-off seen throughout the latter stages of 2011. Upward momentum has mainly been put down to the cold weather, but there has also been some apprehension about the slowing pace of incoming LNG cargoes, helping to rekindle buying interest.
LNG deliveries have been few and far between of late, especially from top supplier Qatar. There have been reports of increased buying in Asia, which competes with us for Atlantic Basin consignments, although market players have also speculated that the slowdown could be due in part to the Qataris getting nervous about the escalating Iranian situation, prompting them to turn down output.
In the end, Iran’s warnings over the Strait of Hormuz may not go beyond rhetoric, but the slowdown in LNG deliveries shows that their sabre-rattling might be having more of an impact on the UK gas market than traders have envisaged, lending indirect geopolitical support to prices. With the conflict poised to escalate, it would perhaps be a good time to consider locking in energy prices sooner rather than later, or else hedging, to limit exposure to such risks.
Tom Woolley is managing editor at The Energy Brokers, an energy consultancy specialising in procurement and risk management solutions.
This article first appeared in Utility Week’s print edition of 2 March 2012.
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