The market welcomed news on Sunday that the US and Iran had agreed to the terms of a peace deal to end the conflict that has roiled the global economy, sending oil prices sharply lower and equities higher.
That deal, which President Trump said on Sunday will reopen the Strait of Hormuz, is expected to be signed in Switzerland on Friday. But even if the signing goes off without a hitch, experts say the oil markets are staring at a long road back to normalcy.
“A return to normalized market conditions immediately upon signature in Switzerland would look optimistic, as sentiment has clearly improved,” said Claudio Galimberti, chief economist at Rystad Energy.
“But sentiment is not the same as supply. It will take time for production to ramp back up, for logistics to normalize, and for the risk premium embedded in crude prices to dissipate.”
A three-to-six-month process
Ever since the war in Iran began on Feb. 28, the count of ships moving through the Strait of Hormuz has dropped from more than 120 per day to near zero. Even with recent reports that a small number of vessels have been daring the crossing in so-called dark movements, levels remain far below normal.
The market’s first problem will be the hundreds of ships trapped on either side of the Persian Gulf and the complex task of moving them through the region and toward their destinations in what will amount to a waterborne version of air traffic control at a major airport.
Those ships must move out of the Persian Gulf, reach their destinations and offload their oil, then make the return journey back to begin refilling from the Gulf — a process that under the best-case scenario would take three to six months, if not longer, said Rodger Baker, managing director of geopolitical consultancy Periplous, “assuming everybody is just happy for everything to go back to normal.”
For that process to begin, shipowners and captains must feel confident that they can safely make the transit without fear of attack, Arsenio Longo, founder of maritime risk intelligence firm HUAX, told Yahoo Finance.
It’s not yet clear who will control the Strait of Hormuz in the wake of a deal or how that control will be enforced, leaving open questions for shipowners, captains, and crew. President Trump said Sunday that he had authorized the “toll free opening” of the waterway, yet semiofficial Iran news agency Fars said Monday that Iran would only allow toll-free crossings for 60 days before levying fees against ships seeking to traverse the waterway.
“Some early voices on the insurance and market side seem to be working on the assumption that the deal may hold, or at least that the worst closure-risk scenario is easing,” Longo said. “But that does not automatically mean captains, owners and operators treat Hormuz as normal again.”
One billion barrel loss
Once oil begins flowing regularly again through the key waterway, the energy market will have deeper structural problems to address.
Since Iran closed down the Strait of Hormuz at the start of the war, the market has lost roughly 14 million to 15 million barrels per day, for a total loss of more than 1 billion barrels, per Goldman Sachs. As that oil has remained stuck inside the Gulf, oil-producing nations throughout the region have had to shut in millions of barrels’ worth of production as their storage tanks reached capacity, a process that can take weeks or months to reverse, according to energy consultancy Wood Mackenzie.
To compensate for the lost barrels, nations and major energy companies have drawn down strategic and commercial reserves to near-record lows. At the oil and processing storage hub in Cushing, Okla., the largest such complex in the country and the primary pricing point for US benchmark WTI crude oil, stocks have been drawn down to within 2 million barrels of operational minimums, said Dylan White, director of North American Crude Markets at Wood Mackenzie.
Even if the strait is to reopen, the seasonal lift in summer demand combined with the “exceptionally large” inventory drawdowns already seen “should push [global inventories] toward operational stress levels by August,” JPMorgan strategists Natasha Kaneva, Lyuba Savinova, and Artem Fakhretdinov said in a note to clients.
The market must also begin the slow process of rebuilding and repairing energy infrastructure targeted throughout the war, such as refineries and liquid natural gas (LNG) terminals, even as the scarce equipment needed for those repairs has been committed to other upstream projects around the world. Rystad Energy estimates the repair bill will likely exceed $50 billion.
‘A step in the right direction’
All of this leaves the oil market in a somewhat perilous position.
While US and Iranian leaders have both confirmed agreement on a memorandum of understanding to be signed on Friday, neither side has published official terms, leaving open questions about key issues, including the state of Iran’s nuclear program, sanctions on the Islamic Republic, and control over the Strait of Hormuz.
The deal, as publicly understood, appears to align with the position of both sides in a way that prior iterations have not, especially as economies on both sides of the war faced increasing pressure, Rystad’s Galimberti said. Yet even if the situation in the Middle East holds through Friday, the deal is likely to represent the initial step of a much longer process, with potential for disruption throughout.
“Washington has an incentive to avoid a spike in gasoline prices ahead of the midterms, while Tehran is seeking sanctions relief and restored export revenues, and the global economy has a strong interest in keeping the Strait of Hormuz open,” Galimberti said. “On rare occasions, these incentives align in a coherent way, and that is the strongest argument that this is more than another short-lived diplomatic cycle.”
Galimberti added, “That said, a signed agreement is not a functioning one … If the deal holds, it will therefore represent a step in the right direction, and an important one at that, but still a step rather than a destination.”
But as with past rounds of negotiations, including the initial ceasefire signed in early April, the situation in the Gulf remains fragile. Strikes inside Lebanon by Israel over the weekend reportedly threatened to destabilize Sunday’s agreement. Iranian state media have reported terms far different from those President Trump has indicated.
That leaves oil markets on a knife’s edge, said HUAX’s Longo:
“In Hormuz, it sometimes only takes one small incident, a disputed inspection, a dark transit read the wrong way, or a strike elsewhere in the Gulf, and the whole picture changes again.”
