Hormuz is a Vanishing Asset - So Are Sanctions
Welcome to an expensive holding pattern.
In response to the “economic D-Day” known as Operation Economic Outcast, Tehran has vowed to let not a “single drop of oil” past the Strait of Hormuz. Epic branding aside, both sides of the conflict have shot their wad and it has changed… well, not a whole hell of a lot.
Global markets are back to where they were on April 13, when the US Navy started its first naval blockade of Iranian ports. But that doesn’t mean that either side will play the same hand. The chatter is that Iran and Oman are, again, discussing a “joint temporary navigational corridor” through the strait. There has been the usual street-lever performance politics denying the secretive note-passing both sides need to extract themselves from this tar-baby without losing too much face. The carrier of said notes, Pakistan, is reporting that “significant progress” has been made to wrap up hostilities - but they would. The shipping sector isn’t buying it.
What has changed is that, by playing their aces, those aces are losing their value. With the Gulf States building out overland pipelines, Iran’c control of Hormuz is a vanishing asset. Arguably, so are President Trump’s sanctions.
Less Than Zero v. Maximum + 1
After 40 years of threats, Iran finally closed the Strait of Hormuz to watch global oil prices climb, but not enough to destroy demand. Now that the spigot has been closed, Iran can’t close it more. China has been willing to buy 90% of Iran’s oil at a $7-12 dollar p/b discount, hollowing out Iran’s windfall in prices. Thanks to the blockade, Iran can’t even deliver oil at a discount.
In D.C., the administration may have rebranded Trump 1.0’s “maximum pressure” sanctions campaign, but it’s hardly new. Iran has been under US sanctions since the kids had their 444 day sit-in at the Embassy in Tehran. The Islamic Republic has never not been under US sanctions and its entire modern revolutionary economy has been shaped - or warped - around this fact. The point of the wider sanctions is to bite Iran’s global network they way it has gone after America’s.
How effective will this be? China has shrugged its shoulders and said that it would do whatever the hell it wants to. If Oman is serious about reopening the strait with Iran, it’s a sign that the secondary sanctions will be largely ignored. But not by all. The UAE is not only a significant trading partner, but facilities much of the regime’s shadow banking needed to evade sanctions. By attacking the UAE early on in the war, Iran may have pissed in the punchbowl – now the Emiratis are clamping down on its shadow banking at US request. They do seem keen on waiting out the conflict without US protection.
What Is This Going To Cost You?
As of this writing, Brent crude has fallen to $85 p/b on reports of a re-opening of the strait. Don’t hang your hat on that price, talks with Oman are political theater designed to show the world that’s the regime is being the sensible one. With the blockade in place, it is not in Iran’s self-interest to re-open. So expect higher prices at least through the end of the year. This will a drag on the global economy, but hardly a crash. Meanwhile, the Arab States are scrambling to build-out overland pipelines, but the best bets are that they won’t be online until 2030. And when they are, those added costs will be passed on to the customer.
The geopolitical concerns are abstraction when pricing durable goods - but we will get presented with a bill. The alliance network that allows the United States to protect such awesome power is largely built on a perceived military deterrent. The knock-on will be that a demonstrated inability to keep the strait open or check Iran - a train-wreck of a country without a viable air force or navy and not much of an army - while both allies and rivals watch will almost certainly lead to free-for-all chaos in global supply chains. And you know how markets feel about chaos.
Mohammad Bagher Ghalibaf, the speaker of the Iranian house, conceded that the country will “not survive” without the economic growth made impossible by the naval blockade and economic isolation. Normally that would be enough to make a second-tier power cry ‘Uncle Sam!’ and have said Uncle foot the bill for reconstruction. Alas, there is very little normal about the Islamic Republic’s revolutionary regime. Unlike the US constitution that bangs on about We the people and how we’re going to form a more perfect union, Iran’s constitution specifically calls out the United States, how awful we are, and then expressly states its intention of pestering us - literally, not figuratively - until the end of days. And that’s when the government is functioning properly. As it stands it looks like the government has lost control of the IRGC - which is playing an entirely different game.
Yet, as I’ve written before, even the IRGC knows that it cannot win a direct conflict with the Great Satan. I’m guessing the play here is for Tehran to hold the current pattern until the midterms, and then decide on the next phase. Like Canada, it is playing a version of Congressional Shuffle, hoping that congress will go Blue enough to geld the president, or even impeach him. The flaw in the plan, if the primaries are anything to go by, is the Democrats doubling down on the same politics that got them run out of power in the first place.
What Next?
Tensions are so high, any graceful exit is going to be tricky. Oil prices will remain volatile within parameters, highish but not enough to do Iran any good. The regime can probably last the rest of the year - after that time is really working against them. There is no good way to predict an “Arab spring” moment, but executions for anti-state activities are reported being held in public now, so don’t count on it. Trading partners may be willing to skirt sanctions, but they are also just as likely to pick a weakened regional bully clean.
As for the immediate economic impact stateside, say what you will about the AI boom, but that sector is about the only thing that kept the US from slipping into recession last quarter. In short, painkillers abound in the American economy. The danger is a weakened alliance network that is starting the hedge against an unreliable chief. That’s a long term erosion that (despite my caterwauling to the contrary) the American voter actually wants. The associated costs of this are, again, abstract enough to hide. I live in Memphis, currently as hot as one of the less fashionable circles of hell. My neighbor is suffering sticker shock on the cost of a new air conditioner - which is roughly twice as expensive as it was five years ago. This thing is the price of a small car.
With the supply chains going haywire, those prices aren’t coming down because, again, the world always presents a bill. I really can’t stress that enough.
