The implications of Red Sea instability on the global LNG market

In recent weeks, maritime attacks carried out by the Iranian-backed Houthi rebels in the Bab el-Mandeb Strait, between Yemen, Djibouti, and Eritrea, along with retaliatory strikes by the United States and its allies, have significantly increased global shipping risks and raised the ire of many foreign governments. More than 40 attacks against commercial shipping have been reported since mid-November 2023, although none have targeted crude oil or liquefied natural gas (LNG) carriers to date. But that is not to say that global energy flows through this critical maritime chokepoint are invulnerable; any harm that came to hydrocarbon carriers traveling into or out of the Red Sea via the Bab el-Mandeb would have far-reaching consequences for international markets.

According to S&P Global, approximately 8% of global LNG volumes transited the 20-mile-wide, 70-mile-long strait in 2023. Most of this traffic in the east-to-west direction has comprised Qatari LNG cargoes destined for European markets. But effective Jan. 15, 2024, Qatar Energy announced the suspension of its LNG shipments via the Red Sea due to the escalation of hostilities. And, as reported by Drewry, a maritime consulting group, more than 90% of global container vessels originally transiting the Red Sea have diverted their voyages to around the Cape of Good Hope.

The gas market impact of the Houthi strikes on Red Sea shipping has been limited to date, due to sufficient global supply, a warmer-than-average northern hemisphere winter, high European storage levels, and new market dynamics brought on by the Russo-Ukrainian war; but the market will undoubtedly experience more profound supply and price volatility should the Red Sea route effectively become closed to commercial maritime transit or the military activity in the region expands and further escalates. Vessels forced to deviate around the Cape of Good Hope incur longer shipping times and higher fuel costs, not to mention additional expense due to scrambled schedules. Even though no price spikes are forecasted at this point, commodity costs will increase over time.

Further market shifts can be anticipated, with Europe potentially trying to secure increased volumes from Atlantic Basin producers, including the United States. At the same time, Middle East suppliers will seek more Asian buyers, which can be reached without having to enter the Red Sea and passing through the Suez Canal (or circumnavigate Africa), minimizing their exposure to the Bab el-Mandeb Strait. In the long term, the Red Sea shipping threats and low-water issues in the Panama Canal, which are complicating passage between the Atlantic and Pacific oceans, may further segment the global LNG market into Atlantic Basin suppliers and buyers on the one hand and Middle East/Australia suppliers and Asian buyers on the other. In this geo-economic market realignment, Saudi Arabia and North American producers could turn out to be the big winners.

Implications

Longer shipping times, higher costs, and shipping risks

As of mid-December, at least three LNG carriers opted for the longer voyage around the Cape of Good Hope, which added approximately 22 days to a round-trip passage from Qatar to Europe. The extra 6,000-7,000 nautical miles translates to an additional $1 million in fuel costs. Insurance premiums are also rising, driving shipping costs higher. The longer shipping times may adversely impact planned port arrivals, loading, and offloading schedules and cause a global rescheduling of the LNG carrier fleet, again adding cost to the final product. By one key measure, the extra 11-day delay to cargo shipments from Qatar to Europe equates to three to four missing cargoes, assuming a ship is offloaded in 24 hours. With prolonged shipping delays in the system and it being the middle of the European winter heating season, European buyers will have to secure spot cargoes as insurance.

Currently, the Houthis seem to be focusing on large container vessels and bulk carriers, but loaded LNG carriers offer handsome targets in their own right. Qatari-flagged LNG carriers may have some inherent limited protection. Still, the Houthis must realize that while the ship is Qatari, the cargo is destined for the European Union, some of whose members are staunch supporters of Israel. Thus, based on Houthi communiques, LNG carriers may be viable targets in the longer term. With more frequent attacks, the risk increases for an “inadvertent” attack on a Qatari-flagged LNG carrier loaded with gas destined for the EU or a ship carrying US-produced LNG. In either case, serious repercussions would be expected, militarily and throughout the global LNG market.

Isolation to regional spread

To date, either through discipline or luck, high-profile Houthi attacks have been limited to the Bab el-Mandeb Strait and have not strayed into Saudi Arabian waters. Soon after the start of the current Israel-Hamas conflict, the Houthis launched several missiles from northern Yemen into the Red Sea in an attempt to reach Israel. Those projectiles all failed to reach their target, but they did transgress Saudi national waters. More such transgressions or “inadvertent” attacks on international vessels in Saudi waters — or even more provocatively, Saudi vessels carrying crude or other energy products — would require Riyadh to take action, pushing Saudi Arabia into renewed war with the Houthis as well as, again, conflict with Iran. The Saudis have remained quiet for now and avoided taking any part in the US-led international deterrence efforts in the Red Sea, but any Houthi actions threatening Saudi interests or assets, direct or indirect, will likely require a change in Riyadh’s policy.

The Houthis have, for years, been supplied by Iran; yet their shift to maritime combat and surveillance operations over the past several months implies a more recent introduction of new weaponry. The international coalition’s pivot from deterrence toward more offensive action may push the Iranians to decide they need to increase their support for the Houthis, resulting in an escalation of hostilities with more widespread attacks on commercial shipping. The originally scripted Houthi attacks on Israeli shipping, or ships carrying Israeli goods, have already metastasized to widespread commercial shipping in the Red Sea, including against US and allied warships. More concerning would be any expansion of hostilities and increased piracy on the other side of the Arabian Peninsula, in the Strait of Hormuz. In a worst-case scenario, simultaneous hostilities in the Strait of Hormuz and the Bab el-Mandeb Strait would drastically impact global energy supply — strategic leverage Tehran has long sought to develop.

Saudi Arabia’s conundrum

As alluded to above, since 2023, the Saudis have assertively sought to de-escalate and disengage from the Yemeni civil war, and in parallel, the Saudis and Iranians have taken steps to rebuild bilateral relations. The recent hostilities in Bab el-Mandeb, however, present the Saudis with a difficult challenge. The governments of Saudi Arabia as well as the United Arab Emirates have been careful not to vocally align with the US on the Israel-Hamas conflict for fear that their populations would view that alignment as anti-Palestinian. At the same time, the Saudis have refrained from taking an active role on the Houthi issue. With the recent US and allied counterattacks on the Houthis, the Saudis and Emiratis have, thus, called for restraint and de-escalation. Future Houthi attacks on Saudi crude carriers or those that occur in Saudi waters would force Riyadh into an uncomfortable decision: whether to align with Washington and its allies or remain quiet. The Saudis will have to juggle among three competing factors: their interests and obligations to global maritime shipping networks and their oil customers, efforts to manage Iranian proxies, and the need to prevent anger and resentment in their population.

That said, as long as Saudi assets and territorial waters remain off limits to the Houthis, the ongoing instability in the Bab el-Mandeb Strait could actually positively impact the Saudi petroleum industry. As regional turmoil increases, Red Sea export points north of the strait would offer the Saudis a competitive advantage on the European markets. But to seize this opportunity, Saudi Arabia would need to expand crude and petroleum product exports from port facilities in Jizan and Yanbu as well as increase export volumes. Second, Saudi Aramco should now execute the plan to expand domestic gas infrastructure to export LNG from a Red Sea port as it develops gas resources from the Jafurah area. Avoiding the congested Arabian Gulf seaways and the politically unstable Strait of Hormuz and Bab el-Mandeb Strait could result in a “de-risked” product premium.

Structural market shift

With the Red Sea waterway under duress and no estimate as to when hostilities might end, the global shipping fleet must consider alternative routes, such as the lengthy Cape of Good Hope voyage. For the global LNG trade, the Red Sea has always been the dividing line between the eastern and western markets for producers and buyers. The Russo-Ukrainian war had already led to an LNG market shift, whereby US LNG producers expanded to fill the void in Russia’s gas supply to Europe. At the same time, the increased US LNG supply to Europe diminished the appetite for other international suppliers. The current instability along the Red Sea shipping lanes will drive buyers to support further US LNG expansion, and spreading instability could also lure the Asian market to secure more North American LNG volumes. The situation as a whole will support the development and expansion of new LNG supply chains that minimize shipping risk. Unfortunately, geographic pinch-points are present throughout the world, and most, if not all, have their own challenges associated with transiting them.

Geopolitical fallout and impact on global LNG

The fallout of the Oct. 7 Hamas attack on Israel is still reverberating globally. More specifically, what started as a horrific act of terrorism has now expanded beyond the Gaza-Israel theater to include more than a dozen countries, impacting the Eastern Mediterranean, Suez Canal zone, Red Sea, Arabian Sea, and Arabian Gulf. Approximately 24% of global oil and 24% of global LNG supply is produced in the Middle East, with an estimated 24% of this regionally produced oil and 20% of this LNG passing through the Strait of Hormuz. Both Qatar and US suppliers of LNG have already suspended the transit of their cargoes via the Red Sea.

For now, although oil markets have expressed some concern, the LNG market has been relatively stable due to significant global supply and no incident of an attack on an energy-carrying vessel in the Red Sea to date. Nevertheless, the long-term impact of the insecurity in the region may result in further geographic segmentation of LNG, with Atlantic producers and buyers building stronger supply lines amongst each other and Asian buyers aligning more closely with Middle Eastern producers. US energy companies stand to benefit from a stronger EU market pull, but West Coast North American LNG (Canada, Mexico, US) will also become more attractive to Asian buyers as they try to avoid the Panama Canal drought issues and geopolitical unrest in the Middle East, thus introducing more competition to Middle East suppliers (e.g., Qatar). Asian buyers will now be evaluating the security of supply and the LNG price. Over the next 5-10 years, while Asian LNG demand grows, North American LNG greenfield projects and brownfield expansions can expect to market support to increase their capacity, and project developers will scurry to secure offtake contracts for new greenfield LNG projects in the US, Canada, and Mexico. Global geopolitics are driving Middle East LNG producers into a more competitive environment with western North American LNG producers, to the benefit of Asian buyers.

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