View / Iran’s energy weapon worked

The deal signed yesterday between Washington and Tehran to reopen the Strait of Hormuz proved Iran’s energy weapon was powerful enough to take on the world’s mightiest military and come out ahead.

Earlier in the conflict, US President Donald Trump repeatedly stressed that the war could only end with Tehran’s “unconditional surrender.” Yet the agreement includes numerous conditions, perhaps most importantly that Iranian oil is back on the menu.

This is a huge prize for Tehran, which prior to February had been forced to sell most of its oil to China at steep discounts because of US sanctions. Iran could stand to gain $60 billion a year by regaining access to the regular market. And when Trump announced the terms of the deal, he was clear about the driving force behind it: “We run out of [oil] reserves in about four weeks. We would really run out. You want to see bedlam?”

One fascinating thing about the past few months has been that bedlam took longer to arrive than many people thought it would, given the world suffered the biggest volumetric disruption to oil and gas supply in history. There was pain at the pump, especially in Asia. European airlines hit some turbulence. And I won’t forget getting hassled by energy curfew-enforcing cops in Cairo. But crude oil prices in Europe and the US didn’t top their post-Ukraine peaks. And now, the International Energy Agency warned yesterday, we’re likely facing a glut. Yet, as the world’s tanks drained out, Trump was clearly able to see a scary-looking cliff approaching fast, and blinked.

It’s too early to say this is all over; one drone could bring the whole thing down. But so far, there are a few key lessons from the crisis.

• Contrary to the central promise of “energy dominance” — that high oil and gas production gives the US an indomitable geostrategic advantage — in this case US drilling was only able to delay the inevitable extreme price spike, to buy time for a deal that mainly achieves a return to the status quo. The US is still, ultimately, at the mercy of the global market. And for now, Iran retains enough control over that market that the US was willing to pay Tehran to reopen it (and possibly to keep it open, if Tehran manages to institute passage “fees”).
• But, the weaponization of oil flows is a “wasting asset,” as one former security official put it to me this week. One big reason this crisis was less painful was because millions of consumers, executives, and political leaders worldwide have already realized the security benefits of reducing their exposure to fossil fuels. Like any other military asset, every time the energy weapon is used, someone on the other side improves their defenses. In the years ahead, the leverage Iran can gain from its control over the Strait of Hormuz will diminish (to “zero,” if the UAE has its way), as will the US ability to use drilling as a shield or cudgel — this week, even an exec from American LNG exporter Cheniere admitted as much.
• Patience is a virtue for producers. The crisis was certainly good for oil companies, but the really booming corner of the business was trading, not drilling; European majors outshone their US competitors in first-quarter earnings because of their robust trading desks. And while some US producers were cautiously beginning to follow Trump’s call for more oil, most remained loath to do so, having foreseen a return to less dazzling prices. That seems like a smart move.
• The political cost of all of this to Trump remains unclear. Given the amount of time needed to fully reopen the strait (the return of pre-war daily oil flows could take until January in an optimistic case, according to Rystad Energy) and the competition that refineries will face for crude with hungry storage tanks, US gasoline prices could fall slowly — although they already dipped below $4 per gallon on Thursday. Analysts think Trump is likely to reauthorize a waiver of the Jones Act, which facilitates oil shipping, but apart from that there is precious little he can do to further drive down prices. By the time the midterm elections roll around, voters will want to know what those costs have bought them, in the form of a strong nuclear deal. Now that race is on.