Iran Deal Crumbling: How Exposed Are Oil Markets

The Iran deal crumbling has become the defining worry for oil markets this month, after both Washington and Tehran broke the terms of a 14 point memorandum of understanding meant to guide 60 days of negotiations toward a lasting peace agreement.

How the Agreement Started Unraveling

The trouble began well before the halfway point of the 60 day window. U.S. Central Command and President Donald Trump accused Iran of violating the memorandum by firing on commercial vessels in the Strait of Hormuz, forcing ships onto preapproved routes and threatening to charge transit tolls. Washington answered by resuming and expanding nightly airstrikes on Iranian targets, a move that itself broke the same understanding it was meant to defend. Tehran declared the memorandum void soon after. Iran's top negotiator, Mohammed Ghalibaf, went further, describing the standoff as an existential war with the United States.

With fewer than 30 days left in the original 60 day clock, the practical question for oil traders is what comes next, and whether the diplomatic track can survive at all.

Why November 3 Matters More Than the Deadline

A Washington source who works closely with the U.S. Treasury told OilPrice.com that the 60 day period is not actually the number that matters most. The real deadline, in his view, is November 3, when midterm congressional elections begin. Trump, he said, does not want to finish his final term as a lame duck and needs both a clear result on Iran and gasoline prices that will not sink Republican chances at the polls.

The math behind that concern is fairly direct. A roughly $10 per barrel move in crude tends to shift gasoline prices by about 25 to 30 cents a gallon. Each one cent increase in the average gallon price drains more than $1 billion a year from consumer spending nationally. Since 1896, the sitting president's party has won reelection in all 11 cases where the economy avoided recession within two years of the vote, but only once in seven cases when a recession was underway. The same pattern tends to hold for midterms. Bob McNally, a former energy adviser to President George W. Bush, put it bluntly: few things frighten an American president more than a spike in gasoline prices.

Four dollars a gallon is the figure that tends to set off alarm bells inside any White House, once the link between pump prices, consumer spending and growth becomes too obvious to ignore. As of last week, the national average sat at $3.85 a gallon, uncomfortably close to that threshold.

Iran's Escalation Strategy Around Hormuz

Tehran appears to understand these political pressures as well as anyone in Washington, according to the Treasury connected source, and that knowledge shapes its strategy. Iran has an incentive to escalate militarily, but only up to the point where the United States would feel compelled to strike major civilian infrastructure in response.