Oil traders call Trump's Hormuz bluff at their peril

LONDON: Iran and the U.S. have both announced rival blockades of the Strait of Hormuz once again, crippling an already fragile ceasefire deal. This should alarm oil traders who had been pricing in a rapid return to normal. But markets appear sanguine - and that may be a miscalculation. The global oil and gas market proved remarkably resilient during the 108-day conflict, thanks in large part to the ample global reserves present before the war began on February 28. But the energy market is no longer protected by ample emergency stocks, so the margin for error has become a lot smaller. President Donald Trump said on Monday that the U.S. was reinstating its blockade of Iranian shipping in the Strait of Hormuz following Iran's declaration over the weekend that it was closing the waterway amid fresh missile and drone attacks between the two sides.

This leaves the June 17 interim ceasefire on shaky ground. Trump also said Washington would become ‌the "guardian of the Hormuz Strait", ensuring ⁠the shipping chokepoint - ⁠through which a fifth of global oil and liquefied natural gas supplies previously transited - remained open to all other vessels.

In turn, the U.S. would be reimbursed at a rate of 20%, Trump added. Meanwhile, Yemen's Iran-aligned Houthis on Monday threatened to disrupt ships transiting the Red Sea to the Suez Canal, potentially opening a new front in the regional war which could challenge cargoes seeking to bypass the strait. The oil market response to all this has been surprisingly subdued. Global benchmark Brent crude futures have risen over 10% to above $80 a barrel since the latest round of tit-for-tat attacks erupted last Tuesday. That rise may be significant, but prices remain well below the wartime peak of $118 reached in late March.


Investors appear to be discounting the chances of a return to full-scale war and a complete shutdown of oil and gas flows through Hormuz.

That is a reasonable assumption - but it is still a risky one.

WHO BLINKS FIRST?
Neither side appears eager to return to war. Iran has been severely weakened by months of U.S. and Israeli bombardment and stands to receive a substantial economic windfall from the interim agreement due to promised sanctions relief, unfrozen funds and potential investment. A renewed conflict would put all that at ⁠risk. Trump, meanwhile, is ‌unlikely to welcome a surge in domestic gasoline prices during the peak summer driving season, especially in the months before the crucial midterm elections in November.

Trump's proposal to impose a fee on Hormuz transits also appears highly fanciful.

For decades, the U.S. has championed freedom of navigation. Any attempt to impose mandatory tolls on vessels merely passing through an international strait would face formidable legal challenges. The U.N. shipping agency said as much ⁠on Monday: "There is no legal basis through which to introduce mandatory tolls simply to transit through a strait."

Does this mean Iran and the U.S. will refrain from implementing their respective blockades?

Probably not.

Both sides likely believe short-term blockades will do little damage to their respective positions.

Tehran is betting that Trump will ultimately accept some form of Iranian oversight of traffic through Hormuz and tolerate fees on passing vessels because of the U.S. president's political vulnerabilities. Trump, for his part, appears to believe that pressure on Iranian exports will force Tehran to abandon its claims over the waterway.

What's more, Trump may have been lulled into complacency by the energy market's remarkable resilience during the war - and the rapid bounce back to prewar prices after the announcement of the June deal. But prolonging this standoff - let alone returning to a new intensive phase of fighting - comes at a much higher risk than it did a few months ago.

NO OIL CUSHION
That's because the world's oil safety cushion has been dramatically depleted. During the 4.5-month conflict, governments, refiners and traders released record volumes of crude and fuel from emergency reserves to offset the loss of around 13 million barrels per day (bpd) of Middle Eastern exports. Those releases helped prevent the kind of price shock many analysts feared at the start of the war, ‌but they came at a cost. According to the International Energy Agency, observed global oil inventories fell by a cumulative 360 million barrels between March and May, equivalent to around 3.9 million bpd. Onshore stocks continued to decline in June, dropping by a further 96 million barrels, or roughly 3.2 million bpd.

The erosion has been particularly striking in the U.S.

Having exported record volumes of crude and refined products during the conflict, U.S. inventories have been drawn down to lows not seen in decades. ⁠Total crude and refined product stocks are at their slimmest since 2003, while gasoline inventories are at their lowest level for this time of year since 2012, leaving an exceptionally thin buffer against supply disruptions.

That vulnerability has not gone unnoticed in Washington.

Earlier this month, Vice President JD Vance argued that the U.S.-Iran agreement would provide the world with time to rebuild depleted oil reserves before any potential resumption of hostilities.

Based on current inventory levels, the world needs a lot more time.

WRONG LESSONS LEARNED
For now, then, the oil market is probably right to assume that neither Trump nor Iran's hardline clerics are actively seeking another full-scale conflict in the Middle East.

The most likely outcome remains a face-saving compromise that allows each government to claim victory.

But that does not mean the danger has passed. Both sides are engaged in high-stakes brinkmanship, which often produces miscalculations. A missile strike, a naval incident or an attempt to enforce rival claims over the strait could trigger an escalation neither side intends.

And unlike in February, when inventories were full and emergency reserves abundant, the global oil market has far less capacity to absorb another major shock.

That may prove to be the most important lesson investors are missing today.

(The opinions expressed here are those of Ron Bousso, a columnist for Reuters.)