By Michael Every of Rabobank
Hormuz update: Comfortably Bomb
Summary
- The US-Iran MoU appears to have collapsed sooner than we had thought.
- With both sides striking the other, US efforts will turn to ensuring energy can flow through Hormuz ‘the hard way’ via escorting ships through it.
- For now, markets are saying the US can ‘comfortably bomb’ and ‘there is no pain’ even if the ‘MoU are receding’, mostly due to finite SPR drains and low Chinese oil imports.
- That gives the US a window for action: if it can keep enough oil flowing through Hormuz, which is our base case, it underlines military action can move markets in a desired direction; if it fails, we face a far larger energy crisis with far less in the tank as mitigants - or a geostrategic reckoning.
We argued the June 17 US-Iran memorandum of understanding temporarily suited both sides but would last, at best, until the US midterm elections and would ultimately collapse due to its inherent contradictions over tolls, sanctions, Lebanon, and uranium. At time of writing on 13 July, the US and Iran have separately declared the “ceasefire” and “diplomacy” as over. Both were striking the other, albeit not yet all-out as at the start of the war. Typically, the IRGC has declared that the Strait of Hormuz is now closed - and the US that it is still very much open for business.
There is no pain
Regardless, the market response has been constrained. At Asian market open on Monday, Brent was only up around 4% to $79, for example (Figure 1). In short, markets continue to treat a new active conflict around the Strait of Hormuz as containable.
That’s the case for several reasons. First, inventory draws have eased immediate pressure. Second, China is keeping its oil imports subdued. Third, some energy workarounds have emerged. Lastly, there has been some demand destruction.
This is not a sustainable long-term dynamic, but for a few weeks, or months at most, the market may continue to say “there is no pain” in spot oil prices even if wide crack spreads were already telling another story on refined products before this latest fighting started.
The key question is if this is a temporary or a longer-term geopolitical issue: arguably it’s both. However, the US may be gambling it can resolve the Hormuz situation to the energy market’s satisfaction before things become critical.
MoU are receding
The Hormuz disagreement stems from the MoU’s Article 5, which stated:
“Upon the signing of this MoU, Iran will make arrangements using its best efforts for the safe passage of commercial vessels, with no charge for 60 days only, from the Persian Gulf to the Sea of Oman, and vice versa. The traffic of commercial vessels will immediately start, and considering the need for removing the technical and military obstacles, and de-mining by Iran, will be instated within 30 days. Iran will conduct dialogue with the Sultanate of Oman, to define the future administration and maritime services in the Strait of Hormuz, in discussions with other Persian Gulf Littoral States, in line with applicable international law and the sovereign rights of coastal states of the Strait of Hormuz.”
Iran took this to mean it controlled all of Hormuz, including outside its own territorial waters, and could toll maritime traffic there.
The US took it to mean that Iran couldn’t and set up an alternative toll-free route via Omani waters. Iran has since attacked ships using this alternative route. That was the proximate trigger for the latest rounds of US strikes on Iranian facilities on islands within Hormuz and along its coastline aimed at degrading Tehran’s ability to project control over the waterway; and of Iranian counterstrikes.
The MoU therefore collapsed over the easiest of its contradictions to resolve, tolls, which could have been relabelled as ‘fees’. That presents a daunting challenge for market optimism as it implies US-Iran tensions are here to stay on multiple fronts.
However, it also focuses the immediate problem –and US and Iranian attention– on physical control of Hormuz.
A distant ship smoke on the horizon
The message from US CENTCOM is clear: “The Strait of Hormuz is open to all vessels seeking to lawfully transit the international waterway. US forces are positioned and prepared to ensure that freedom of navigation remains available despite unwarranted Iranian aggression, harassment, threats, and arbitrary declarations. Iran does not control the strait. Traffic is flowing.” In pledging this, the US aims to ensure that Hormuz doesn’t bother markets the way that it did earlier in the war. That implies:
1. Taking out Iranian facilities in and along Hormuz so the threat to the southern Omani channel is diminished.
2. Providing defensive cover for ships passing through from drones, missiles, small boats, and mines, etc.
3. Shielding GCC allies, particularly their energy and critical infrastructure, but where stocks of missile interceptors are reportedly low. Very notably, Iran has so far not struck at these key GCC facilities again in recent attacks. That could suggest Tehran realises there are limits to what it can do to its neighbours if it also wants to offer alternative regional leadership ahead.
These US tasks, mirroring the late-80’s Operation Earnest Will in the Iran-Iraq War's Tanker phase, may require help from the GCC and NATO. While US allies have been reticent to (publicly) act in this regard until now –and the Saudis blocked Operation Project Freedom with the same goal– that dynamic may change with the recent narrow avoidance of an energy crisis and the narrative that Iran alone is now blocking Hormuz.
Moreover, it has been revealed that the US continued with a covert version of Project Freedom anyway without Saudi assistance.
You are only coming through in waves
It’s credible to assume US (and GCC/coalition) naval escorts with air cover could move substantial energy volumes through Hormuz via Omani waters even under duress. Recent operational data suggest the US military directly escorted tankers carrying significant amounts of oil successfully through the Strait. The US claims this was as high as 7 million barrels per day. Sustained throughput of meaningful amounts of oil and products via these military escorts appears theoretically feasible, albeit at higher costs from insurance premia and longer transit times. That turns a serious supply shock into a manageable disruption.
At the same time, it’s realistic to expect that on top of a cancelled Iranian oil sanctions waiver, the US could reimpose its blockade on Iranian oil to increase economic pressure on it.
We can also expect more efforts to build alternative supply chains and pipelines that avoid Hormuz as possible around it. None of them are a short-term palliative to match the Saudi East West pipeline to Yanbu, but in the longer run they will reduce Iran’s leverage even further.
Your lips move but I can’t hear what you’re saying
President Trump has called the Iranians “liars” and “scum” and Iran has stated it wants “revenge” and to kill him. Both sides have made their red lines explicit and have shown they are prepared to enforce them kinetically. The most positive near-term path is continued tit-for-tat pressure, punctuated by attempts at limited talks that produce little beyond contradictory statements.
Markets pricing for a resolution of this crisis from a diplomatic perspective or a ‘TACO’ are likely wrong. However, US hard power could also achieve the same benign outcome.
I can’t explain, you would not understand
Markets and analysts are rightly confused by all the contradictory signals being seen around this crisis: declining inventories, wide crack spreads, the renewed cut-off of Iranian oil, intensifying military action and perhaps more later – yet energy prices have not blown out. It perhaps helps to underline who has been winning and losing and who could emerge as the final victor and how.
This is not how I(ran) am
Iran was heavily beaten militarily while exposing key US defensive weaknesses; then it was handed a win in peace negotiations due to energy market pressure on Trump; now, with oil prices contained, it has overplayed its weak hand and is under a new phase of US pressure:
- Iran could potentially lose effective control of Hormuz.
- Iran gets no sanctions relief as well as no oil sales if the US blockades it.
- Iran gets no assets unfrozen nor a $300bn in FDI for an economy shattered by the recent war.
- In Lebanon, peace progress has been on Israeli and Lebanese not Iranian/Hezbollah terms;
- Iran’s proxy in Syria has been lost and is working on a pipeline to help Iraq avoid Hormuz; Iraq’s pro-Iranian militias are being constrained by the government; the Houthis remain quiet; and Hamas has agreed to cede power in Gaza, if not disarm.
- Iran’s highly enriched uranium will clearly not be discussed, with reports Tehran is trying to rebuild its nuclear facilities. The US will have to address this too, but that perhaps via the air rather than boots on the ground, as in 2025.
- None of that means the US is aiming at regime change even if Israel says it is. Yet, Tehran could find itself regionally shrunken, economically ‘caged’, and geopolitically ignored.
But that’s only if the US wins the Battle of Hormuz. As repeatedly stressed, a US defeat or retreat would flip the script. That’s why we have continuously argued the US will use kinetic force (and, if absolutely necessary, radical economic statecraft in the energy sector, i.e., NAFTA > NAPHTHA)
I have become Comfortably Bomb
Markets can therefore enjoy a form of geopolitical anaesthesia: “geopolitical risk equals higher energy prices” is not firing fully because so much oil has been injected into our global system.
The US SPR cushion could last a few more months at current rates of depletion; so could Japan’s SPR; and China has kept its oil import volumes subdued and has vast reserves. Indeed, there’s little logic --beyond a statecraft escalation vs the US-- for China to restart buying oil aggressively while the US undertakes military action to try to free up Hormuz which, ordinarily, would suit China. (The only caveat being that Iran has promised a ‘friends and family’ discount to Chinese ships on its proposed tolls.)
As such, the market seems to be telling the US to ‘comfortably bomb’ – but only on the unspoken assumption that its attempts to keep Hormuz open work. That is our geopolitical base case given the historical track record and the overall stakes.
However, if it fails, and/or if Iran steps up its attacks against GCC energy and infrastructure regardless of the regional bridges (and refineries and desalination plants, etc) that it burns, then we would face a serious global energy crisis, and with much less left in the tank as potential mitigants.
At the least, the US --with midterms looming-- would again have to pause until after them; and at the most, we could see the return of narratives heard a few months ago and still echoing in places - that the US is unable to use its military power to achieve its strategic goals, with enormous geopolitical and geoeconomic consequences.
The full implications of that thought should be enough to leave any strategist comfortably numb.
