Photo-Illustration: Intelligencer; Photo: Getty Images
J.D. Vance can sell the new memorandum of understanding between the U.S. and Iran as hard as he wants, but it’s difficult to avoid two obvious conclusions: The U.S. failed to achieve any of its major goals in the war it launched alongside Israel in February, and the agreement winding down that conflict appears quite favorable to Iran. Case in point: One of the big “victories” Vance and the Trump administration keep touting — Iran reopening the Strait of Hormuz — was of course the status quo before President Trump and Prime Minister Netanyahu wreaked havoc on the global economy while inadvertently installing an even more hardline regime than the one they decapitated.
But most people affected by this shambolic military operation care less about political wins and more about rising prices and when they might come down again. Iran’s near-closure of the Strait of Hormuz and bombing of many of its Middle Eastern adversaries had a profound negative effect on far more than just oil production, hitting countries across the world — including the U.S. — in sometimes unexpected ways. The question now is how quickly the flow of goods can snap back to something approaching normal. I spoke with Gregory Brew, a senior analyst on Iran and oil at the Eurasia Group, to get some answers.
How are you thinking about this deal in practical terms, based on what we know?
In my view, an agreement at this stage really needs to do two things: end the war and reopen the Strait of Hormuz. Based on the details that have been made available, it looks as though this MOU does that. I think it’s notable that both the Americans and the Iranians are framing this as an end to the war, but not to the U.S.-Iran confrontation that’s going to continue. They’ll still be hostile toward one another, but overt hostilities will be coming to an end as a result of this deal. That’s the first piece.
The second piece is reopening the Strait of Hormuz. It has long been my understanding that this would require a degree of financial incentives for Iran, to compel their compliance in allowing it to reopen. And the MOU appears to do precisely that. Iran is getting some amount of its funds unfrozen in overseas accounts; it’s unclear exactly how much, but it’s somewhere between $10 and $20 billion. We’ll probably never know for sure. Also, it was long my suspicion, but has been recently confirmed, that the United States would likely give Iran a sanctions waiver, allowing it to export oil at market prices for a period of time. Finally, Iran is expecting the U.S. to end its blockade that has been in place since April, and just today it was reported that several Iranian oil tankers have exited the Persian Gulf and are now carrying their oil east toward China. That’s the most important part of this agreement: Iran is receiving some economic incentives. But the more tangible benefit that Iran has drawn is what it demonstrated during the war: an ability to close the strait and keep it closed even in the face of withering aerial bombardment by both the U.S. and Israel. That’s something that no one will be able to take away from them.
Everything else substantive — Iran’s nuclear program, the possibility of broader sanctions relief, a conclusion to the conflict in Lebanon — is likely to be mentioned in the MOU but not settled. That will require subsequent rounds of negotiations.
Last time we spoke, you said that once a deal is reached to open the strait, it would take a month for volumes to resume. Since this ended up dragging on so much longer, does that timeline look longer now?
I think the actual reopening of the strait will happen fairly quickly. Within a month we’ll see flows resumed to around a third or perhaps half of what we saw during the prewar level. There’s two reasons for that: The first is that there is now an international coalition in place ready to support the movement of ships through the strait. The U.K., France, India, even China have positioned warships in the Sea of Oman that are prepared to provide security to sweep mines and to ensure that ships are safe as they exit or move back into the strait to resume the flow of goods. In addition to that, some volume of shipping has returned to the region. There are between 50 and 75 empty ships that are now sitting in the Sea of Oman waiting to resume traffic through the strait.
So I think what we’ll see is a phased approach. There will be an exodus as hundreds of ships that have been trapped in the strait since February move out and back out into the open sea. After that, there will be a gradual process of resuming east-west traffic, with international actors providing additional support. That will facilitate a recovery in the flows of oil, the flows of refined products, and the flows of natural gas, but it will take longer — probably between three and four months — for the region to return to normalcy. It will take time for regional producers to reverse shut-ins in Iraq and Kuwait. Virtually all oil production has been shut-in in Saudi Arabia, and in the United Arab Emirates, it’s between a third and a half. The process of reversing those shut-ins will take time and will have to be managed in a slow, gradual fashion to avoid damaging oil fields.
Next, there will be an expectation of a rush of oil and other products as ships exit the strait. After that, the market will watch as regional producers recover their output. Prices are likely to stay elevated because it’s going to take months for regional output to recover to what it was before the war.
To ask a parochial question: What does this mean for elevated gas prices in the U.S.?
One of the more interesting aspects of this crisis, at least to me, has not been the way that the price of oil has increased, but rather the fact that the price of oil has not increased as much as many analysts would have predicted. It managed to get above a hundred dollars a barrel, but it persistently stayed lower than many analysts would’ve expected. And now that we have a deal, it has been falling rapidly. Moving forward, this will hinge on whether the deal comes together, whether it moves forward on schedule. But if those efforts proceed and the strait reopens and the flow of goods and energy out of the Persian Gulf resumes and recovers back to prewar levels, that would suggest quite a lot of downward pressure on prices of goods, including the price of oil. That doesn’t mean we’re going to see an immediate relief of the higher prices that we’ve seen over the last several months, but it does suggest movement in that direction.
As you said, there’s been some surprise that prices didn’t go up to, say, $150 or $200. Instead, they were mostly in the $85 to $110 range for the duration of the war. Why is that?
There are four key reasons why prices increased but didn’t reach the excessively high levels that some people feared. The first reason is that China dramatically reduced its oil imports. Oil imports in China fell from 11 million barrels a day in December to just over 6 million barrels a day in May. That reduced pressure on the global market and freed up more barrels for other consumers, other importers. The second reason is large-scale reductions in inventories. Both strategic petroleum reserves and commercial inventories have been drained over the last three months, so that demand doesn’t need to fall. Draining inventories is usually a sign of prices staying high moving into the future, but the market has been relatively sanguine when it comes to inventory releases meeting short-term demand because of the expectation that it would be a temporary measure, since we would have a deal.
There has also been some demand destruction. It’s a little hard to know for sure because the data is fragmentary, but between 2 and 3 million barrels a day of demand has vanished from the global market. It’s scattered across the world. It comes in the form of reduced jet-fuel demand in Europe, reduced petrochemical production in Southeast Asia, reduced diesel consumption in South Asia and Southeast Asia. There’s likely been a degree of demand destruction inside China, which has facilitated the drop in oil imports. So that’s taken additional pressure off the market. Finally, a steady stream of tankers that have gotten out of the Strait of Hormuz. It hasn’t been much, but if you look at the average over the last several months, it’s between 2 and 3 million barrels a day carried on tankers that were either Iranian or were national tankers that were traveling dark and sneaking through the strait with their AIS transponders off. So all told, that’s been enough to keep the market stabilized. Though with the inventories being drained as rapidly as they are, it was always going to create a lot of pressure to reach a deal in the short term before the buffers were reduced and we started seeing increased price pressure in July or perhaps August.
I had been under the impression that China had an oil reserve that the rest of the world was only dimly aware of, and that this had something to do with prices staying down.
If you look at things in terms of market power, that comes from two places. One is the ability to change levels of production — so if you think about Saudi Arabia being the world’s swing producer, Saudi Arabia’s market power came from the fact that it could change production levels relatively easily and relatively quickly. That gave it the ability to move prices up or down depending on its perceived interests. No other nation on Earth really has that ability, not even the United States, even though the U.S. is producing far more oil than Saudi Arabia.
On the flip side, market power can come from adjusting levels of demand, and that was something you saw happen a little bit in 2022 with President Biden’s decision to release a large volume of oil from the U.S. Strategic Petroleum Reserve that affected supply, but it also helped support demand in the wake of Russia’s invasion of Ukraine. And since the United States couldn’t adjust its oil-supply levels, it could draw from its strategic petroleum reserves in order to affect the market in that way. What China has done is exert market power by drastically cutting demand, which mirrors something that China was doing all of last year. China was importing oil in excess of its consumption, probably between 1 and 2 million barrels a day of extra oil that China was importing from places like Iran and Russia and Venezuela, and most of which just went into strategic inventories. That helped to keep prices a little higher last year. Now the Chinese have been doing the opposite. They’ve dramatically reduced demand, and that’s helped put a ceiling on prices keeping them from climbing too high. So the takeaway for me is that China has demonstrated an ability to affect global oil markets that is arguably much greater than anything any other state on Earth has been able to achieve, including Saudi Arabia and the United States.
And what about the U.S.? Prices have gone up, but they’re not as high as they were in 2022 after Russia invaded Ukraine. Is that because of the country’s huge production capacity?
Domestic gasoline prices tend to move in lockstep with global crude prices. Global crude prices have been where they are in part because the United States is such a prolific oil producer and in part because the United States can produce so much of its own refined products. So that has helped to keep domestic gasoline prices low.
When you look at the prices of gasoline and diesel in other consuming markets — in Europe, gasoline prices are much higher than they were four months ago. That’s part of why we’ve seen a degree of demand destruction in the European market. In the United States, there has been an increase in gas prices, but it hasn’t been calamitous. That is down to the fact that the U.S. is a major producer, but it’s also down to the fact that crude prices haven’t spiked as high as some might’ve predicted. Moving forward, once the Strait of Hormuz reopens, that will keep prices lower than $120 or $150 a barrel. But because of how heavily inventories have been drained and because of the length of time it will take for regional production and the global market to stabilize, gasoline prices in the U.S. are likely to stay at least above $3.50 cents a gallon, if not higher. So not disastrously high, but I would say annoyingly high for anyone in office.
And Iran now knows it can make this happen again at any point.
A deal is only coming together because of what Iran has achieved in the strait. Its ability to close the strait is now its greatest source of leverage, and it is the leverage that Iran has used to bring about a deal which is pretty favorable to Iran and far more favorable than anything the United States was willing to offer Iran before the war.
This interview has been edited for length and clarity.
