The outline of conditions and topics for a negotiated settlement of the U.S.-Iran conflict called a Memorandum of Understanding (MOU) and signed by both sides last week in all probability won't prevent the approaching energy cliff. That cliff will be the result of fast-depleting commercial and strategic inventories of oil and oil products around the world that have acted as buffers in the wake of the suspension of almost all tanker traffic through the Strait of Hormuz during the conflict—tankers believed to carry about 20 percent of the world's daily needs of oil.
As I explained in a previous piece, the world is fast approaching "tank bottoms," that is, the depletion of usable oil and oil products inventory. When that inventory effectively runs out, there will be a bidding war for oil and oil products to replace the millions of barrels per day that will still be needed but unavailable from inventories as the drama in the Persian Gulf continues.
As of this writing, the Strait of Hormuz has been closed by Iran in response to continuing attacks by Israeli armed forces in Lebanon. The first provision of the MOU is that hostilities are to cease immediately everywhere including Lebanon as a pre-condition to further negotiations. Just as important as whether the strait is open are what each side means by the word "open" and how shipping companies and the insurance firms who insure their tankers understand the risk of transiting the strait.
According to frequent unofficial spokesman for the Iranian government Seyed Marandi who is a professor of English and Orientalism at the University of Tehran, the strait will likely be managed in a way to carefully meter traffic at rates far below those seen before the beginning of the war, that is, assuming it does, in fact, re-open.
Although insurance has been available for ships passing through the strait at costs believed to be five times pre-war rates, the cost of hiring tankers for the journey appears to be skyrocketing, that is, when such tankers are even available. One of the biggest fears of shippers continues to be that they cannot be certain that ships entering the Persian Gulf will be allowed to come back out—as conditions appear to be changing from day to day. The many uncertainties are therefore likely to keep many shippers away, and uncertainty works in Iran's favor as Iran's newly minted Persian Gulf Strait Authority can claim the strait is "open" while also saying it can't force shipping companies to come through.
There is every reason for the Iranians to keep traffic to just the minimum required to claim that the strait is open so as to allow negotiations to move forward while simultaneously continuing to deny the world economy adequate supplies of oil, liquefied natural gas, and other key products such as sulfur and fertilizer.
As the energy cliff approaches, oil prices will likely regain and perhaps exceed their previous highs. As the resulting pain transmits through the world economy including the United States, the Trump administration will be incentivized to come to a stabilizing agreement as quickly as possible. The United States can't do that without successful negotiations and Iran has now made it clear that those negotiations may not move forward unless the United States lives up to the conditions set in the MOU. Even as the Iranian foreign minister traveled to meet American negotiators in Switzerland, Iran's Fars News Agency reported that the Iranian delegation will "demand the other side implement its commitments" agreed to in the MOU. Iran can and will open and close the Strait of Hormuz when it chooses in response to the fulfillment (or nonfulfillment) of those U.S. commitments. Control of the Strait of Hormuz has now become the central way in which the Iranians can enforce the provisions of the MOU.
In addition, even if the current strait closure is resolved quickly and negotiations proceed, the MOU calls for 60 days of negotiations. The Iranians can count, and they must have known when they signed the MOU that tank bottoms around the world would almost certainly arrive DURING the negotiations. That would lead to price spikes in oil that would weaken the position of the United States forcing U.S. negotiators to give Iran more of what it wants in exchange for a quick resolution.
It is not certain as of this writing that negotiations will actually proceed anytime soon apart from the Iranians demanding that the pre-conditions set forth in the MOU be honored. That means the euphoria of last week upon the signing of the MOU will likely dissipate as the reality of continuing drawdowns of oil and oil product inventories comes to the fore.
No doubt the Trump administration will once again try to jawbone the oil market downwards and that may work for a short time as it has in the past. But eventually no jawboning from the administration or from anyone else will be able to overcome the loss of inventories—unless those wanting lower oil prices have figured out how to repeal the laws of physics. If that happens, I promise complete coverage of the event as it will be the most important scientific marvel of the age.
Kurt Cobb is a freelance writer and communications consultant who writes frequently about energy and environment. His work has appeared in The Christian Science Monitor, Resilience, Common Dreams, Naked Capitalism, Le Monde Diplomatique, Oilprice.com, OilVoice, TalkMarkets, Investing.com, Business Insider and many other places. He is the author of an oil-themed novel entitled Prelude and has a widely followed blog called Resource Insights. He can be contacted at kurtcobb2001@yahoo.com.
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