Last week’s selling spree continued yesterday as the latest week got underway. Facts and narratives pointing in the same direction resonate with investors, who, perhaps justifiably for the time being, are ignoring the hurdles that lie ahead in securing a long-term peace deal between the US and Iran, which are discussed below. The US Vice President reported progress in the talks with Iran, claiming that Tehran has agreed to nuclear inspections by the International Atomic Energy Agency, potentially beginning as soon as this week. At the same time, the US Treasury Department issued licences allowing the sale of Iranian crude oil and refined products. Estimates vary, but Iranian officials confidently claim that 25 million barrels passed through the Strait yesterday. Nevertheless, numerous questions remain and will only be answered at a later stage. In the meantime, investors are adopting the most reasonable approach, reacting to headlines and high-frequency data.
 

Still a lot to Ponder

There has been a palpable shift in the trajectory of the Iranian conflict and, consequently, in market sentiment. All one needs to do is glance at a graph of any major oil futures contract’s price movements. Brent, the European crude oil benchmark, is some $50 below its end-April peak and $19 cheaper than it was before the ceasefire extension was announced a little over a week ago. The Memorandum of Understanding (MoU), signed by the warring parties, called for the reopening of the Strait of Hormuz while nuclear talks take place. Oil has indeed started to transit the Strait in considerably greater volumes than before. Kuwait, for one, lifted all force majeure notices issued during the war. Since the US also lifted its naval blockade, Iranian oil exports appear to have accelerated, too. Three US-sanctioned supertankers carrying 6 million bbls of Iranian crude entered the Strait yesterday, Bloomberg reported.

The halt in hostilities and the resumption of oil flows through the Strait are welcome developments, both politically and economically. The decline in oil prices does not imply that doubts about uninterrupted oil flows or setbacks in nuclear talks are emerging. Nevertheless, these questions need to be asked and answered as thoroughly as circumstances allow.

Regarding the first issue, it is useful to turn to Energy Intelligence. In the latest issue of its Petroleum Intelligence Weekly (PIW), it acknowledges that the return to normality has begun, yet warns that the process may prove drawn out, or at least more protracted than the current euphoria suggests. There are tangible uncertainties surrounding the logistics of oil transit through the Strait of Hormuz. Although, according to the MoU, both the US and Iran will ensure the free passage of oil through the Strait immediately, the initial surge in volumes currently moving through the chokepoint could slow considerably in both the short and medium term.

PIW, citing data analytics firm Kpler, points out that around 12 tankers are expected to sail through the Strait over the next 30 days, approximately half the pre-crisis figure. The most serious impediments to sustaining the current increase in flows are safety concerns and logistical constraints. Some estimates put the number of tankers stranded outside the Strait at 200, roughly half of which are already laden with crude. Ship owners and operators will require assurances that the threats posed by mines have been fully eliminated. Damaged ports, debris in the water, and congestion present additional obstacles to an unconditional ramp-up in traffic. Loaded tankers will take priority, meaning that inbound shipping lanes may need to be used for outbound vessels. Once this backlog is cleared, incoming tankers will load from storage; however, doubts remain as to whether a sufficient number of ships will be available to enter the region. Shipbroker SSY estimates that crude loadings in the Atlantic Basin increased by nearly 50% in May compared with the first quarter, and redeploying cargo ships to the Middle East could take as long as two months. Over the longer term, managing traffic through the Strait remains an unresolved issue, as does the tentative toll proposed by Iran in the recent past.

These logistical hurdles will be compounded by political and diplomatic obstacles. Current efforts, namely talks in Switzerland, are aimed at transforming the 14-point MoU—which one US Democratic senator has dubbed the "Memorandum of Misunderstanding"—into a permanent, stable, and credible peace framework for the region. Such an agreement would ultimately deprive Iran of nuclear weapons while guaranteeing the right of both Israel and Palestine to coexist peacefully. The MoU calls on the parties to reach a mutual agreement on the handling of Iran's 9,000 kg uranium stockpile, 440 kg of which is enriched to levels close to weapons grade. It appears implausible that Iran would relinquish its right to enrichment voluntarily. As the Obama-era JCPOA demonstrated, securing nuclear concessions is far more feasible through negotiations than through airstrikes.

Another emerging point of contention is Israel's growing international isolation. The country's relentless scorched-earth policy in Lebanon is complicating and could ultimately paralyse the nuclear talks. A lasting peace in the region will not be achieved while Hezbollah, one of Iran's principal proxies, retain significant influence. However, the current flare-up in tensions is also part of Benjamin Netanyahu's effort to secure victory in the legislative elections planned for October and thereby avoid corruption and bribery charges. Since one of Iran's preconditions for nuclear negotiations is the cessation of strikes in Lebanon, the ongoing hostilities may become yet another factor capable of derailing the talks.

The JCPOA negotiations took 20 months to conclude, despite being conducted in an environment characterised by greater trust and less animosity than exists today. If an enforceable, robust, and amicable agreement is the ultimate objective, it will take time to negotiate, with inevitable setbacks and interruptions along the way. If it is a deal for the sake of a deal, it will likely break down soon. In either case, the direction of oil prices will depend largely on whether regional supply is adversely affected.

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