Blockade of the Strait of Hormuz - A “knife fight in a telephone booth” ?

The more and more explicit nuclear rhetoric and the threats of a blockade of the Strait of Hormuz may soon cause the conflict to escalate. We described two years ago what the temporary shutdown of this neuralgic location of global energy trade would entail. The Strait of Hormuz connects the Persian Gulf in the West with the Gulf of Oman and the Indian Ocean in the East. The strait is about 180km long and, at its narrowest point, only 55km wide. Almost 35% of the oil shipped by sea and 20% of global oil production is transported through this maritime eye of a needle on a daily basis.

Production and exports at the Persian Gulf

Sources: IEA, Bloomberg, Datastream, Erste Group Research

A blockade would come with dramatic short-term consequences. China would be particularly hard hit. More than 40% of the Chinese oil imports pass through the Strait of Hormuz. This means that Iranian oil is more important to China than Saudi Arabian oil is to the US.

When comparing the military capacities, we do not believe that Iran is able to block the strait for an extensive period of time. According to the Economist Intelligence Unit, Iran may have a large (about 520,000 soldiers), but outdated army. The military budget amounts to about USD 13bn (by comparison, the US defence budget is USD 554bn).
According to International Institute of Strategic Studies the Iranian Navy, which is based at the estuary of the Strait of Hormuz, is currently about 190,000 men strong. It owns many small and manoeuvrable torpedo boats and patrol boats. The strait does not favour large war ships by definition, in the New York Times a US military official has called a military confrontation in that region a “knife fight in a telephone booth”. The biggest threat on the Iranian side is probably posed by the three highly advanced submarines of Russian design, which can deploy sea mines. At the moment Iran owns about 2,000 sea mines and a fleet of mini-submarines of its own production.
By comparison, the US clout is enormous. The Fifth Fleet is based in Bahrain and usually comes with 1-2 aircraft carriers, 6 cruisers, and 7 destroyers. Capacities are being expanded as we speak. In addition, the UK has dispatched the HMS Daring, one of the world’s most modern anti-air warfare destroyers. The Iranian air force would probably have a hard time trying to defend itself in this uphill battle.
Even if Iran managed to maintain a blockade for only a short while, the consequences would be dramatic. The oil price would definitely set new all-time-highs and might reach USD 200. The long-term effects are difficult to assess. Iran would retaliate and probably attack the pipeline infrastructure as part of their guerrilla tactics, and generally try to destabilise the region. This would also come with a huge impact on the freight industry in the region, because sea shipments could hardly be insured any longer.

We regard doomsday scenarios as exaggerated given that the oil reserves of almost 1.5bn barrels (1.27bn of which crude) could offset supply outage for a couple of weeks. On top of that, Saudi Arabia is slightly more flexible with regard to its export routes. Three pipelines go to Yabu at the Red Sea, with a capacity of 4.5mn barrels/day. In addition the UAE is planning to complete a pipeline with a capacity of 1.5mn barrels/day from Abu Dhabi to the Gulf of Oman by summer. The pipelines would definitely mitigate the effects on the oil market, but not fully neutralise them.

Cui bono?

Iran would score an own goal with a blockade. The fact that all important tanker terminals are located on the side of the Persian Gulf means that a blockade of the strait would affect the Iranian oil exports just as much. Iran is hugely dependent on the oil sector. The sale of oil accounts for more than 60% of tax revenue and 80% of export revenue. Due to the lack in refinery capacity Iran also has to import the majority of its petrol and heating oil.
Although the first thing that comes to mind in connection with a possible blockade is the shortfall in oil, we believe that the impact on the LNG market would be substantially more severe. Qatar is by far the biggest producer of LNG with a market share of 25%. But in contrast to oil, there is no way of avoiding the Strait of Hormuz for LNG. This means that more than a quarter (Qatar and UAE) of global LNG capacity would be affected.

Breakdown of LNG producers in terms of total production 

Sources: BP Statistical Review of Energy 2011, Erste Group Research
The majority of exports of liquefied natural gas cross the Persian Gulf on its way to Asia. Japan, India, and Korea are the most important buyers. Consequentially these countries would be hit on both ends by a blockade – on one hand by a decrease in LNG deliveries, on the other hand by the drastically rising oil price. Japan would be particularly hard hit, having switched largely to gas after the Fukushima disaster. Also, Japan is one of the last industrialised countries to still use high quantities of oil in its power production. Japan would probably have to ration energy if the supply chain of oil or LNG were to be disrupted .
LNG deliveries from Qatar and UAE 

Sources: BP Statistical Review of Energy 2011, ERSTE Group Research