Strait of Hormuz Closure Effect on LNG Market

| December 28, 2011 | 0 Comments

Iran’s Vice President Mohammad Reza Rahimi announced yesterday that if UN sanctions are not lifted then he will close the strategic Strait of Hormuz, the worlds most vital Oil check point.

Located between Iran and UAE, this small area of sea plays host to about 40% of the worlds Oil tankers and so is vital to world oil supply.

Strait of Hormuz

Strait of Hormuz

What the media seem to have missed when reporting this story is that the closure would also have a dramatic impact on the Liquefied Natural Gas market and would have far reaching consequences for counties that have a large dependency on LNG for their domestic energy needs.

Cargoes that have been liquefied in Qatar or Kuwait have to pass through the Strait of Hormuz regardless of which destination country that they will eventually end up. There is no other way out of the persian gulf for domestically produced gas and there is not going to be an alternative route unless the planned pipeline between Qatar, Iraq and Turkey goes ahead (proposed in 2009).

Qatar is the worlds single largest producer of LNG and combines with Abu -Dhabi, produced just over a quarter of LNG this year (see below graph) – THE BELOW GRAPH SHOULD READ ABU-DHABI NOT KUWAIT (Kuwait only has regas!)

World vs Qatar LNG Production

The LNG market is much tighter than the global Oil market as due to the volatile nature of LNG and the associated boil-off there is no cost efficient way to store LNG for an extended period of time. Therefore unlike oil, countries that rely on LNG to meet their domestic power burn requirements and heating have to have a regular supply of cargoes. More regular supplies are needed if the country in questions has poor on-shore infrastructure as capacity constraints will mean that they have poor short term storage and have to flow the gas when it arrives in port.

Countries like America that are dependent on oil, have their own domestic production as well as national strategic reserves (in the US’s case this is about equal to 8 days of maximum demand) so they are partially insulated against a physical supply shock. However countries like Japan and South Korea have very limited domestic supply or storage of either Oil or LNG and so a physical supply shock such as the closure of the Strait of Hormuz would be very damaging indeed.

Since the Fukushima Nuclear Power Station disaster, the Japanese Nuclear power station production load factor has been consistently below 50% and last week hit an all time low of 13% as power stations that are due for routine maintenance by law have not been allowed to restart. Due to this, Japanese utilities such as TEPCO, CHUBU and KANSAI have had to expend their thermal production capabilities to plug the shortfall. As a result LNG imports have exeeded 80million tons in 2011, up from 69 million tons in 2011.

In the wake of the Fukushima disaster Qatar promised Japanese utilities an extra 9millions tons of LNG exports until March 2012. Any delays to cargoes heading to Japan from the Persian Gulf would have a devastating impact on japanese utilities as they have no other generation that they can turn up in order to meet domestic demand. Admittedly, this analysis does assume that the Japanese Government would not allows any currently out of action nuclear power stations to restart (something which is not out of the question).

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