Rising tensions in the Middle East after the killing of General Qassem Soleimani by a U.S. drone strike in Baghdad and Iranian retaliation against two Iraqi bases housing American troops early Wednesday sparked fears over the unpredictable actions by Washington and Tehran or their proxy allies in the region.
In particular, military escalation has affected commodity markets, with oil prices running up as much as 4 percent in the immediate aftermath of the ballistic missiles attack and Brent crude busting through the $70 threshold. As soon as President Donald Trump declared the United States’ readiness “to embrace peace,” U.S. crude futures erased the recent gain and ended below their January 2 value, logging their biggest percentage drop since late November in just one day.
Energy is central in Trump’s Middle East strategy, and this has was confirmed by his Wednesday speech. As Trump affirmed, the United States achieved “energy independence” and is now “the number-one producer of oil and natural gas,” thus allowing Washington to change its strategic priorities in the region and daringly challenge Iran in its near-abroad.
Despite the likelihood of an open conflict between U.S. and Iran seeming slight, all countries depending on energy imports from the Middle East, including LNG, aim to develop possible hedging strategies in case the situation worsens. The tipping point could be an unexpected situation originating from the initiative of one of the many actors exacerbating the U.S.-Iranian quarrel. As an example, last September Houthi rebels claimed responsibility for a drone attack on a large oil processing facility in Saudi Arabia. Or tankers may become the target of other raids, as happened to two Japanese ships in June.
As the price volatility of oil and oil-related products is likely to continue, in response to political turbulence, the UAE energy minister said that the Organization of Petroleum Exporting Countries (OPEC) is ready to guarantee that the market “is well supplied” and the world can enjoy “healthy economic growth.” Nonetheless, he also said that all countries in the world would be affected if supply through the Strait of Hormuz is cut.
Indeed, the U.S. Energy Information Administration (EIA) named the strait as the world’s most important oil transit chokepoint in 2018, due to the 21 million barrels per day (b/d), the equivalent of about 21 percent of global petroleum liquid consumption and one-third of total global seaborne traded oil, flowing through the same Strait of Hormuz.
Yet, not much attention has been granted to the political importance of the Strait of Hormuz for Liquefied Natural Gas (LNG) trade, as Qatar and the UAE both use the maritime channel to supply an estimated volume of 81 million tons to world markets. Qatar, with around 25 percent of global LNG supplies, plays a leading role in the world’s LNG industry. Additional factors like regional interconnections (from Qatar to Kuwait) or the imports of LNG in Dubai, Kuwait and soon to Bahrain, could further increase the significance of a closure of the Strait for global LNG trade.
China, India, Japan, South Korea, Singapore, and Taiwan are all heavily relying on imports from Qatar, and these countries are going to be the first to suffer an eventual tightening up of volumes available on international markets. Last June, Japan’s Chief Cabinet Secretary said that “ensuring the safety of the Strait is a matter of life and death in terms of energy security and it is extremely important for the peace and prosperity of the international community.” Then-Defense Minister Takeshi Iwaya, meeting his U.S. counterpart, hinted that Japan might be interested in a future US-led coalition to protect the Strait. Under the plan approved by Prime Minister Shinzo Abe’s cabinet, a helicopter-equipped destroyer and two P-3C patrol planes will be dispatched in the Middle East to “make sure Japan-related ships can sail safely in the Middle East.”
The impact of any disruption will depend on a mix of different aspects determining the extent of the crisis. Still, as explained by Nikos Tsafos, Senior Fellow at CSIS, three main adjustments are likely to happen simultaneously: first the remaining LNG volumes flowing toward richer consumer countries; second the countries with access to domestic gas will struggle to increase the use of it; and finally, those consumers which can switch to alternative fuels or lower consumption will do so.
According to independent gas and LNG consultant David Ledesma from the Oxford Institute for Energy Studies, “spot Asian LNG prices would rise to reflect the concern that Middle Eastern LNG supply could be reduced if the Strait of Hormuz was closed or supply through the Strait limited.”
The U.S. Maritime Administration (MARAD) remains cautious and has already warned ships that “there remains the possibility of Iranian action against U.S. maritime interests in the region.” Similarly, Japan’s Mitsui O.S.K. Lines (MOL) issued a new warning to its ships, inviting them to keep a distance from the Iranian coast and avoid Iranian waters transiting the Strait of Hormuz. Another major Japanese shipowner, NYK Line, maintained its safety measures in place which include maximizing the speed when passing through the Strait.
Last September, Sunao Nakamura, JERA’s managing executive officer, said that the company, which is world’s largest importer of LNG, was carefully following the situation in the Middle East and the attacks on the Saudi Arabia facilities as LNG prices in a big portion are linked to oil indices. JERA is a joint venture between Japanese Tokyo Electric Power Group and the Chubu Electric Power Group.
In December, China imported a record high monthly volume of LNG, overtaking Japan as the world’s top importer of LNG for the second consecutive month, up nearly 16 percent from its November imports and at the same time launched the Power of Siberia pipeline, a “seminal project” connecting the Chinese gas grid to Gazprom’s assets in the Russian Far East. China’s import volumes are impressive considering that in 2015 the country imported less than a quarter of what Tokyo did. Natural gas consumption is encouraged by Beijing as part of its “make China’s skies blue again” policy, and is seen as an alternative to coal, especially for the domestic heating and industrial sector, thus reducing both sulfur dioxide and nitrogen oxides emissions.
Still, while China has a sizable indigenous production of natural gas, the first among the Asia-Pacific countries and the 6th in the world, its neighbors like Japan, South Korea and Taiwan are roughly 100 percent dependent on LNG imports. Turmoil in the Middle East can easily restart competition among the Northeast Asian countries for accessing new energy supplies as it did in the mid-2000s. Back then, attention was all on oil, but with China’s turning to gas for domestic exigencies and structuring its response to climate change, natural gas could be the heart of a new dispute.
Mitsui and state-backed Jogmec have already pledged $3 billion in the Arctic LNG-2 project managed by NOVATEK, securing also a long-term contract for about 2 million tons of LNG. Moreover, last September MOL and Japan Bank for International Cooperation (JBIC) signed a cooperation agreement for marketing LNG produced in the Arctic LNG-2 and Yamal LNG plants. This agreement will allow Japanese companies to also enter the NOVATEK’s transshipment projects in Kamchatka and Murmansk, where LNG will be stored and then delivered to European and Asian markets. During the last visit of Japanese Foreign Minister Motegi to Russia, trade and economic cooperation were at the center of the meetings with both his Russian counterpart Sergei Lavrov and Russian Minister of Economic Development Maxim Oreshkin.
In the end, Trump’s adamant move in the Middle East and his unwillingness to further commit American troops in the region could have important consequences on the Asia-Pacific energy security scheme. American “abstinence” from oil in the Middle East could transform this phase into a boon for Russia, NOVATEK and Gazprom’s strategies in Northeast Asia, seriously backfiring on the U.S. expanding LNG industry and Washington’s overall geopolitical interests in the region.
Francesco Sassi is a Ph.D. candidate at the University of Pisa. His research interests are focused on the use of National Oil Companies as foreign policy tools and energy security issues in Eurasia.