Dire straits: Hormuz flare-up underscores precariousness of US-Iran MoU; oil market on edge

Will the recent flare-up be contained, or will it again expand into a wider conflict, and what will be the fate of oil and gas flows through the Strait of Hormuz — these are the key questions on everyone’s mind. How the situation evolves hereon will be a major factor in the oil price trajectory; prices had touched multi-year highs of well over $100 per barrel amid the supply disruption. The crisis was particularly trying for large Asian importers of energy, including India, as a bulk of the oil and gas flows that transit the strait are consumed by Asian economies.

Meanwhile, US President Donald Trump said that he thinks that the US-Iran MoU is “over”, even as peace talks between Washington and Tehran continue. The US has also revoked its sanctions waiver for Iranian oil, which would effectively make Tehran’s crude unpalatable for most of the world, except for perhaps China — a regular buyer of Iranian oil. While it may be too early to expect definitive answers to these questions, industry insiders and experts expect both the US as well as Iran to de-escalate and avoid a return to the full-scale confrontation.

“Despite this being the worst exchange of fire between the US and Iran since the June 17 MoU and Trump’s subsequent claims, the tentative ceasefire might still hold. Neither country would want to go back to full-scale conflict. Iran’s targeting of the three ships transiting the Strait of Hormuz was perhaps to try to force vessels to use its new designated route. The strikes on Iranian coastal positions by the US were a warning of sorts. Iran’s response, though, of loosening fire at Bahrain and Kuwait could signal that Tehran is willing to push the envelope more and embroil the region in turmoil again,” an international energy and shipping expert told The Indian Express.

All eyes on Hormuz

The critical maritime chokepoint of the Strait of Hormuz lies at the centre of the latest flare-up, as well as the resurfaced worries around the trade flows. The critical energy trade artery had been free for navigation prior to the war that began late February, but since then, Iran has been claiming sovereignty over parts of the narrow waterway between the country and Oman. During the war, Iran actively regulated the flow of vessels through the strait, allowing only a handful to pass, that too using routings dictated by it.

Following the June MoU with the US, Iran continues to insist that vessels should cross the strait only through the routings designated by it, and that too after seeking its permission. Tehran also plans to impose a service fee for transits, but at a later date. Iranian state television reported that the ships that came under attack on Tuesday were sailing outside the shipping lanes authorised by Tehran.

On the other hand, the US and its allies have been encouraging vessels to use the strait’s waters hugging Oman as an alternative to Tehran-designated lanes. The stark differences in the MoU’s interpretation and the vagueness in its terms have now emerged as the flashpoints in the uneasy ceasefire, as per market watchers.

“At the heart of the matter is that the MoU between the US and Iran included provisions aimed at reopening the Strait of Hormuz to commercial shipping, but it left important details on control and traffic management deliberately ambiguous. Iran maintained that parts of the Strait fall within its territorial waters and that it exercises sovereignty over them, while the US position was that the Strait is an international waterway with rights of transit passage for all nations. This fundamental difference in interpretation was never fully resolved in the text of the agreement,” Tony Sycamore, market analyst at IG Australia, said in note.

“In this context, it remains to be seen whether this morning’s US strikes bring a swift end to the latest escalation or whether Iran elects to continue flexing its leverage over the Strait with actions that fall short of triggering a broader conflict. At the very least, it will keep markets on edge and does suggest crude oil prices have based for now,” Sycamore said.

According to Abu Dhabi-based energy analyst Natalia Katona, while vessel movements through the Strait of Hormuz have not stopped following the recent attacks, “the nerves are back”, and the road ahead could be “very bumpy”.

“Three Qatari LNG carriers turned around (after the recent attacks), as did the Lila Vadinar carrying around 2 million barrels of Kuwaiti crude. At the same time, three stranded VLCCs (very large crude carriers) managed to get out. So the strait is not closed, but every transit is becoming a fresh risk calculation,” Katona told The Indian Express.

“The removal of the Iranian waiver will not take huge volumes off the market, because Iranian crude never really made a major comeback during the waiver period. But it changes Tehran’s incentives. Iran now has much less reason to keep Hormuz open for its own exports…That is why I think the road ahead could be very bumpy. We may not see a formal closure of Hormuz, but repeated attacks, selective delays and another de facto blockage are all very possible,” she added.

India and Strait of Hormuz

Apart from grappling with a physical supply disruption, soaring energy prices due to the West Asia crisis have hit India hard. Around 40% of India’s crude oil imports, 60% of its LNG imports, and a whopping 90% of its LPG imports came from West Asia through the strait. The country’s dependence on imports stands at over 88% for oil, 60% for LPG, and about 50% for natural gas, which is imported as LNG.

India, like various other nations, has been wishing for a quick end to the conflict and a rapid normalisation in global energy flows. While highly diversified crude sourcing has helped ensure adequate oil supplies, the government was forced to ration gas supplies to certain industries and commercial consumers to ensure adequate availability for households and some priority sectors, and even take some emergency measures to prevent panic buying of fuels. As the situation visibly improved following the MoU, some of these measures were recently rolled back by the government.

Moreover, the surge in international prices forced India to import oil and gas at extremely high rates, as the country had to prioritise supply security over price considerations.

As India imports 1.8-2 billion barrels of crude oil a year, every $1-per-barrel increase in oil prices bumps up the country’s oil import bill by up to $2 billion on an annualised basis. According to a March report by Nomura, India is among the three most vulnerable Asian economies to high oil prices in terms of import bill and current account balances, the other two being Thailand and South Korea. It said that every 10% oil price increase typically widens India’s current account deficit by 0.4% of the GDP.

“India is not facing any immediate supply shock, but the risks are rising again: more expensive freight and insurance, delays to Iraqi and Kuwaiti cargoes (as they depend almost entirely on Strait of Hormuz), and tougher competition for Russian and other non-Gulf barrels,” Katona said.