Ground Truth | Escalation and energy shocks in the Strait of Hormuz

When resolution is unlikely, resilience is the strategy.

Escalation and the Memorandum of misunderstanding 00:00 – 03:09 

Caspar Leighton: Welcome to Ground Truth, the podcast from Control Risks. This is the place to hear the best insights on how we're helping organisations across the world with strategic intelligence and security. I'm your host, Caspar Leighton. 

As we're recording, the US is reimposing its blockade of Iran. Missiles and drones are hitting targets on land and at sea. After a brief period of cautious optimism and an uptick in traffic, the number of ships passing through the Strait of Hormuz has shrunk back to a negligible trickle. 

Negotiations continue, but increasingly it seems like the two sides are talking about different things. The document, signed on 17 June, is looking more and more like a memorandum of misunderstanding. To make sense of it, I'm joined by three colleagues who have been helping our clients navigate the conflict since its beginning. 

Sorana Parvulescu is Control Risks' Global Head of Geopolitical and Country Risk, and she joins us from Dubai. With me in the studio is Arran Kennedy, from our maritime risk team and based in London. And joining us from New York, we have Barnaby Fletcher, a principal in our geopolitical and country risk practice, covering all things American. 

Sorana, if you could tell us first: what was in the memorandum of understanding, and — crucially — what was not in it, that means we're in the situation we find ourselves in today? 

Sorana Parvulescu: So the memorandum was an initial deal, if you like, to build some trust. It was centred around finding a gradual way of opening the Hormus, finding a gradual way to open the Strait of Hormuz, in exchange for some effectively monetary gain for Iran. There were two aspects: one was unfreezing Iranian assets, and the second was lifting sanctions on Iranian oil specifically. 

By following those steps, you'd get to a gradual opening of the Hormuz — and there were a few details in there around how that would work. It would have been a confidence-building measure if you want, that would then unlocked discussion of everything else: all the other issues that weren’t put on the table around Iran's nuclear capabilities, its proxies around the region, and on intercontinental ballistic missiles. Those were pushed out to kind of get over this first hurdle. But as we know, we're still at the hurdle. 

Caspar Leighton: And so what is Iran's negotiating position? Because, unlikely as it seems, negotiations do continue amidst all this exchange of fire. 

Sorana Parvulescu: It's nuanced. The MoU is very vague in some of the terms, and I think the Iranians are interpreting it quite literally, vis-à-vis them controlling the Hormuz. So the big debate has been: how much will Iran open Hormuz, and the US lift the blockade, to allow the next steps to happen? Essentially whats happening, the US is trying to allow more ships through the Hormuz than Iran is prepared to let through — before Iran can see that the US is meeting its other obligations. 

An erratic Washington: how US policy shifts overnight 03:09 – 04:57 

Caspar Leighton: So, Barney, I'm crossing to you now. The US has imposed a blockade of Iran again. Where does that fit into the grand plan — if there is indeed a grand plan? 

Barnaby Fletcher: That's a good question — whether there is a grand plan. I don't think it's controversial to say the US position has been, and remains, erratic. President Donald Trump has famously declared an end to this conflict no less than 38 times. 

There is an element of strategy here. There's no serious question that Trump views unpredictability as a negotiating tool. But there's also the fact that the formal decion-making, policymaking structures of the federal government have been weakened under the Trump administration. 

But what it means, the undermining of it means major policy decisions are now made by Trump after discussion with a relatively small group in the Oval Office — so this would include Rubio, Hegseth, Vance, Caine, Ratcliffe, Witkoff, maybe a few others. 

We see these changes in policy happen very, very quickly, going from a commitment to negotiations, to the reintroduction of the blockade, to strikes etc. What we have is a conflict entered into by the US without clear strategic objectives, with conflicting views within the cabinet. Vance and Wiles, for example, clearly more worried about the domestic impacts; Hegseth more hawkish and clear vacillation between wanting to be rid of this whole thing, for it to come to an end and not wanting to be seen as losing. And to be clear — for the US, leaving Iran in clear control of the Strait would be seen as losing. 

What is at stake in the Strait of Hormuz 04:57 – 07:07 

Caspar Leighton: So we've got vacillation in the United States and, perhaps in Iran, a much more laser-like focus on keeping control of the Strait of Hormuz — a decades-old posture they've rehearsed and practised, and which we'll see play out now. Arran, in the Gulf of Oman, what are ships and clients experiencing right now? 

Arran Kennedy: For all intents and purposes, the situation now is the same as in the very early days of this conflict, which is Iran attacking ships with high-impact weaponry that has a real risk of causing total loss of the ship itself and also crew casualties on board. 

The work we were doing in the early days and weeks of this conflict, so whether that be advising underwriters so they can calibrate their policies, whether that was assisting salvage companies looking to go to the aid of stricken ships, whether that was vessel operators looking where to position their trapped ships in the Gulf for relative security, or whether that was charterers of ships, looking to understand how the situation in the Strait might evolve in the coming weeks and months, all of that work we were doing then, we are still doing now. 

But there've been a few developments since then. So, for really kind of two or so months, Iran had virtually complete control of the Strait. Iran mined the typical shipping lanes used by ships in and out of the Gulf. But it established its own shipping lane further north, and ships that received Iran's permission — and in some cases paid a toll to transit — were able to pass. Now over time, the US developed a degree of protection system over the waters south of the shipping lanes, and that allowed a trickle, then more of a flow, particularly after the MoU, of ships to leave the Gulf. But what we’ve seen is that as traffic has picked up, Iran has once again used this asymmetric naval system it's developed — missiles, drones, fast-attack craft, explosive-laden drone boats — to keep a lid on that, if you like, non-Iran-administered traffic. 

Caught in the middle: the Gulf states' impossible position 07:07 – 09:03 

Caspar Leighton: And Sorana, how is this affecting the other countries in the Gulf? How are they responding to the effective disintegration of the ceasefire? 

Sorana Parvulescu: The Gulf countries in general have been at the receiving end of this crisis in the sense that they're not active players in it, in many respects — they're almost risk-takers in this situation. And of course some have suffered more than others, with Saudi Arabia, the UAE and Oman have alternative ways of allowing some exports, although they've still taken some of the hits from Iran. Whereas you have Kuwait and Bahrain really trapped by their geography — and Qatar of course and Iraq as well. So it's slightly two halves, in terms of how they're experiencing this. 

But for all of them, it's really a difficult predicament because they’re trying to on one hand, to influence the US to make sure the conflict doesn't expand or doesn’t re-escalate to the point that it threatens life in the Gulf and the wider economy of these countries. But equally at the other end, they cannot accept a Hormuz controlled by Iran, simply because that like it does now, it would have control over their exports to markets. So, it’s a very difficult position they’re in They're also trying to seek their own negotiation pathways with Iran, understanding that ultimately the US might come and go, but they'll be left in the region with the neighbour they have to interact with. It's a very difficult dance when you have really the US and Iran are talking, or more threatening each other than talking to each other, and they’re sort of in the background trying to manage the situation. 

The midterms and Republican division 07:07 – 12:22 

Caspar Leighton: Barney, you mentioned the decision-making process in Washington. But how is this playing out among the American voting public? Because of course we can't forget the midterms are coming in November. Is this conflict causing political pain in America? 

Barnaby Fletcher: So, all the polling shows the Iran conflict is unpopular, and that the impact of the conflict is unpopular. I separate those two out because what the polling does show is that inflation is even more unpopular than the conflict, especially among Republicans — even though both are unpopular and inflation is obviously affected by the conflict. 

Unpopularity is obviously an issue, and, as you say, the midterm elections are coming up in November. Republicans face a very difficult task retaining the House of Representatives. They're defending a very slim majority, and in the past hundred years the president's party has only made gains in the House in three midterm elections. Polls are actually suggesting the Senate may be in play, despite a very unfavourable map for Democrats this year — which is again testament to the unpopularity of the Iran conflict, but also some of the other actions the administration has taken and the wider economic picture. 

There is some speculation about how much Trump actually cares about this — how much he actually cares about the midterms. We think he does, though, and there are certainly some in his administration, such as Chief of Staff Susie Wiles, who do really care. 

But even before we get to the midterms, you are asking about the political pain and if we look at that more broadly... Trump has to contend with growing Republican divisions. His administration has now lost War Powers Resolution Act votes in both the House and the Senate. These are essentially votes that seek to limit executive authority to conduct military action without congressional authorisation. Both of these votes, one in the House, one in the senate, passed with the support of Republican lawmakers who are either choosing to retire at the end of their terms or were defeated in primaries earlier this year by Trump-endorsed candidates. In other words, they don't have that much to lose, because their careers are coming to an end. 

Now, these votes don't actually mean anything in practice. Congress has never successfully invoked the War Powers Act to stop the executive conducting military action. They don't have anywhere near enough votes to override a presidential veto. But they are embarrassing. They're exacerbating divisions within the Republican Party. They're calling into question Trump's previously unassailable control of it. There's also the possibility, as we move forward, if there's no end in sight of this conflict, of Congress using other legislation — including appropriation bills and other spending bills — to exert pressure on the executive to end or in some way restrain its actions in Iran. 

No good outcomes: the most likely path ahead 12:22 – 14:50 

Caspar Leighton: So where does the solution to this situation come from, Sorana? 

Sorana Parvulescu: That's the million-dollar question, isn’t it? I'm sure many capitals around the world wouldn't have the answer. The reality is that we're in a position where there's no good outcome; it's more about what the trade-off is, and where the parties can meet. 

The most realistic scenario, in our view, is that we drag the situation out. It’s hard to say if it’s the good one or the bad one, but the alternatives aren’t pretty either. So, effectively you have the scenario in which the situation drags on, where you have occasional escalations: as soon as traffic picks up a bit through the Hormuz you come back to these escalations where Iran is trying to pare back traffic, the US responds, and we have a tit-for-tat cycle for a few days. And then there are some talks — or talks about talks — to de-escalate a bit, and then we go around the full circle again. That's probably the most likely scenario at this point in time, because it's very hard to see how a more decisive outcome would work out. 

One alternative is a significant escalation — back to a larger military campaign, the US expands its targeting, Iran responds across the Gulf, maybe to Israel as well, and we're kind of back to where we were in February or March. But the reality is that both sides now know—in particularly the US, apart from the political constraints that Barney was talking about — that the military option is not going to resolve the situation, it will just sort of prolong. We now know how far US military strikes can go in reducing Iran's capability, and we assume they are also rearming. We also know the Gulf countries are lobbying hard to make sure this doesn't happen again, because they absorb most of the pain. 

The third option is some sort of deal or agreement — and that's really hard to get to. As we've seen in the last cycle of escalation, if anything we're back to square one.  

Could the midterms force a change in US strategy? 14:50 – 17:52 

Caspar Leighton: It seems like the one thing that might move the dial is a significant change in the American political landscape. Barney, if the midterms go as predicted too, could that create a situation where the White House is subject to a different form of pressure and has to change its position? 

Barnaby Fletcher: It seems unlikely. Foreign affairs, military action, although constitutionally Congress has the power to declare war, realistically military action and foreign affairs have very much been the prerogative of the executive. I mentioned before, both the House and the Senate have passed War Powers Resolution votes seeking to curtail Trump's actions in Iran. But in order to override a presidential veto they need a two-thirds majority, which they don't have and even after the Midterms, that is not going to change. 

I expect that there may be some more pressure, but there are other factors that are probably bigger sources of pressure on the Trump administration — including energy prices, popular support, also including US armaments, and the fact that stockpiles of missiles etc arebeing severely depleted. That's raising concern within the Republican Party and among defence analysts. 

Caspar Leighton: Sorana, how does that look from your perspective? 

Sorana Parvulescu: I do think, implicitly or explicitly, there's a longer-term strategy here in some ways— or calculation — on both sides. But the question is how much cost and pain each side can take to get there. 

On the one hand, the US administration has been doing something in the background, which is to try and strangle Iran and the IRGC as much as possible — whether its through tightening sanctions enforcement in Iraq and other neighbouring countries for example, or trying to limit the influence of Iranian proxies in countries like Lebanon and Yemen. There is a calculation that the longer you keep this chokehold on — now destroying key infrastructure for Iran that carries goods from other parts of the world. It is essentially adding up to a strategy where it’s trying as much as it can to strangle the IRGC financially, in the hopes that the pressure’s building up internally and eventually the regime cracks. 

On the other side, Iran is counting on the fact that the longer it keeps the Hormuz closed, the more pain it adds to the global economy and to the US administration in particular — to gain that additional leverage. Neither seems to be getting very far right now, from what we’ve heard. So again, it's a question of who blinks first. 

A weaponised chokepoint: Iran's new leverage over global shipping 17:52 – 19:50 

Caspar Leighton: So, Arran, if one thing is clear here, control of the Strait of Hormuz is absolutely critical to Iran's survival strategy. How does that play out in the coming months and years now? 

Arran Kennedy: Before this war, this year, Iran was only ever likely to follow through on its long-standing threats to shut down the Strait of Hormuz if the regime was existentially threatened. But that was a potentially risky move. Why? Because there was a risk the strategy would fail, and that the far superior conventional US military forces would essentially break through that blockade attempt. 

Now, what Iran has done is Iran has finally proven it can not only shut down the Strait, using all the tactics I described, but then sustain that shutdown over time. The longer-term consequence of all of that is that Iran will be more willing in future to weaponise the control it has over the Strait. Now in the future, Iran may use that leverage less sparingly, against less significant threats — doesn’t necessarily have to completely shut down the Strait. For instance, it could selectively blockade an adversary, such as a GCC state over which Iran wanted to gain some leverage. Iran could selectively blockade that state. 

All of that is to say, countries in the region and globally will be looking at ways to diversify away from the Strait. So if you're in the pipeline-construction business, or the ports-infrastructure business, you're going to be incredibly busy over the next few years as countries seek to wean themselves off this reliance they have — with an Iran more willing than ever to dictate the movement of ships in and out of the Gulf. 

The energy shock that may still be coming 19:50 – 23:52 

Caspar Leighton: And Sorana how does that impact global energy security going forward? 

Sorana Parvulescu: Adding to what Arran saying — it's not just energy. We're talking about oil and gas markets, petrochemicals, fertilisers, and shipping as a whole, that is looking at alternatives. And probably the longer the Hormuz stays closed, we will see more essentialstructural adjustments in these markets. 

We'll see players moving away from the Gulf to try to recreate that capacity elsewhere. We're already seeing, in our work, early interest in alternative oil and gas exploration in places around the world, which maybe people hadn't looked at in a lower-price environment, but are now reconsidering.  

The energy question is really key. If this scenario plays out long term, as we think it will, the real question is whether we've yet to see the true energy shock. We've used up some of our petroleum and gas reserves, the Petrochem's and the releases we've seen over spring and summer have reduced some of the impact of the shortages. But the reality is we still don't have those barrels moving through the Strait, and they're not going to pop up elsewhere in the millions of barrels a day, because that capacity just doesn't exist — it isn't online right now. So, really the question is, as we move into the cold season in the Western Hemisphere, and the planting season for agriculture, the question is whether we're still yet to see the major economic fallout from this crisis — because that's when it's going to start to pinch much more. 

Caspar Leighton: And what regions of the world are most severely affected by that outlook? 

Sorana Parvulescu: The transmission belts are multiple. So, of course we have had very serious impacts early on in the crisis for themore emerging economies — particularly Africa and Southeast Asia — partly because they're highly dependent on oil and oil-product imports, and also more dependent on short-term prices. The bigger players have long-term contracts that allow them to be more protected from some of the shocks. The smaller players have a kind of triple vulnerability if you want: they pay more on the spot market, so they're more affected by price spikes; they have weaker currencies, so they quickly end up with problematic balance sheets; and that affects their credit ratings and so on, which then turns into them being more indebted in the same currency. 

First, you have the big Asian players that are very dependent on oil and gas from the Gulf — China, Japan, Korea and so on. We see a bit of cushion there because China has clearly moderated to reduce some of the impact, but that impact is coming. Then we see impact very much in Europe, because of the compounding effect of them being on short-term gas prices on the back of the Ukraine crisis and now being very much — the UK very much being one of them — impacted by the spike in short-term prices on the gas market because of Qatar's inability to export gas. 

And we're now seeing more news from China that manufacturing prices are increasing at the factory gate. China is the factory of the world effectively; everyone imports those goods. So that's a transmission channel that will feed into the global economy over the coming months and translate into inflationary pressure across the world, in addition to shipping and energy increases.  

Insulated but not immune: why the US still feels the shock 23:52 – 26:41 

Caspar Leighton: Barney, that China dynamic sounds like something that would wash up on American shores. How much of the rest of the world's impacts are felt in the US? 

Barnaby Fletcher: There's been a lot of talk about how the US is less impacted by Strait of Hormuz disruptions, because it's a net energy exporter. That's true — but that’s also not to say it's unaffected. The US has been exporting more oil and gas due to the disruptions in Middle East supply, with crude and petroleum exports reaching record levels in recent months. This has been actively encouraged by the administration. But at the same time, the US Strategic Petroleum Reserve has reached its lowest level since the early 80s, and the price of gas has spiked. The administration has been trying to encourage more production — in fact since before this conflict, since it first came to office — but with limited success, because shale gas producers see this as a period of volatility and don't want to ramp up production if it's going to come to an end. 

There are two factors that exacerbate the issue for the US specifically, despite the fact it is an energy superpower. The first is the expectation and forecast of energy demand because of data centres: installed generation capacity has plateaued since the 2010s, and now forecasts show demand massively expanding because of data-centre developments driven by AI. That's already causing political issues, as voters see electricity prices increase along with demand. The second is that gasoline specifically — not energy broadly, but gasoline specifically— is a uniquely politically sensitive issue for US voters. Very simply, because US voters own more vehicles, own bigger and less fuel-efficient vehicles, and drive more frequently and for longer distances than voters in any other country in the world. So, the US may be partially insulated from some of these disruptions, but that's certainly not to say it's immune — and certainly not to say these aren't becoming very pressing political issues for the administration. 

When resolution is unlikely, resilience is the strategy 26:41 - end 

Caspar Leighton: So this crisis has now been going on long enough that it's clearly starting to make permanent-feeling changes to supply chains, and to the way organisations and businesses conduct their global affairs. How are we advising clients to hedge against this enduring uncertainty and to protect themselves against whatever may come down the line in the months and years ahead? Sorana? 

Sorana Parvulescu: Having spoken with clients from really around the world over the last few weeks and months, the first thing is to focus on what's relevant to them, and to assume this is the longer-term situation. What the uncertainty is driving is really a killer for business, because they don't know what input costs to count on. It's less the spike in cost, and more the uncertainty about how long it will last and how it will play out. So our recommendation generally is to assume, based on our analysis, is to assume higher costs for longer — that's the more cautious way to plan. 

The second is around carving out what's really relevant to the business from the noise in the market. To Barney's point earlier, we've had at least 30 calls of the war is over, and declarations about the Strait being open or closed every other day. We've had talk about a deal or no deal — the MoU was seen by some clients as a deal; it wasn't. So really understanding the structural issues driving the situation, and what they mean for markets, rather than taking the declarations at face value. That is, I think essential. 

And the third is working through scenarios — getting into the habit of testing your business strategy against scenarios for some of these big issues, based on your main vulnerabilities, your main suppliers and your main clients. How can you protect your business long term from some of these shocks, by thinking through the potential outcomes. 

Caspar Leighton: Okay, that's about all we have time for on this edition of Ground Truth from Control Risks. I'd like to thank our contributors: Barnaby Fletcher in New York, Sorana Parvulescu in Dubai, and, with me in the studio, Arran Kennedy. Thank you all very much for listening and watching, however you consume this podcast. Do stay tuned for the next edition, coming out in just under a month from now. Goodbye for now.