How to understand the deal made with Iran

Director’s Blog XXV by Stephen V. Arbogast

Monday June 15 broke with the news of an announced deal among the U.S. and Iran.  Details remain private pending this week’s negotiation of ‘technical terms,’ and an expected signing ceremony late in the week.  Some details have leaked out.  Both the U.S. and Iran will end their blockades, and the Strait of Hormuz is to open to all traffic, including Iranian shipments.  Negotiations are to continue for 60 days, during which time the status of Iran’s remaining enriched uranium stocks will be determined and reciprocating sanctions relief granted.  If fully enacted, the sanctions relief could be large. The U.S. side has intimated that Iran has agreed ‘in principle’ not to pursue a nuclear weapon.  Supposedly, no terms were concluded regarding Iran’s future ballistic missile program or support for militias such as Hezbollah – much to Israel’s dissatisfaction.

Until the technical details are resolved and a formal, signed document emerges, much of this must be considered speculation.  Of particular importance are the details around Iran’s stores of enriched uranium and the timing and pace of sanctions relief.  A deal which strictly ties release of Iran’s financial assets to physical surrender of its stockpiles and a credible regime for subsequent inspections would look like an accomplishment.  Sanctions relief in return for Iranian promises of future actions would repeat the mistake of trusting the word of a regime which maintained for decades that its nuclear program was entirely peaceful despite mounting evidence to the contrary.

There is also the question of what happens if, after 60 days, Iran fails to perform under the terms of the agreement.  Twists and turns in this story are very possible.  Let’s explore the lay of the land underlying this agreement and consider what it implies for the most likely outcomes.

We should begin by considering why the two sides have reached this agreement in the first place.  A reasonable guess is that both the U.S. and Iran saw their negotiating positions being undermined by physical conditions that were approaching a breaking point.

To date, the U.S., with the help of efforts in many other places, has been able to contain the economic damage inflicted by Iran’s closing of the Strait of Hormuz.  Industry experts repeatedly wondered why oil prices remained relatively low even as an estimated 12-15 MB/D of oil supplies were blocked from exiting the Persian Gulf.  Slowly, reasons why were identified.  Spare capacity elsewhere absorbed some of the shock.  Large quantities of reserve stocks were released in the U.S., Europe and China. Commercial inventories were also drawn down. The biggest factor, however, seems to have been demand suppression in Asia.  China sharply curtailed its petrochemical industry which relies on oil feedstocks as raw material.  Various forms of rationing took hold in countries from India to Indonesia.

However, global commercial inventories are now an issue.  Over the last 10 days oil industry executives repeatedly warned that a physical limit for this drawdown was approaching fast.  TotalEnergies CEO Pouyanne estimated that 10-13 MB/D of inventories were being consumed, leaving the market with “clearly some very low inventories.”  Chevron’s CEO Mike Wirth echoed this concern, commenting that inventory levels would soon be “uncomfortable” and that the key question was how much longer reserve draws could contain the market’s supply risks. Continued stalemate in the Persian Gulf might then mean more physical shortages worldwide and the long-feared oil price spike (e.g., $150/B) happening.  With domestic support for the conflict already eroding and the Midterm elections now in sight, this proved a prospect President Trump did not want to allow to materialize.

The Iranian side of this equation is harder to read.  That regime is well practiced at maintaining a resolute face to the world regardless of the internal damage and disarray it is absorbing.  That said, it is reasonable to speculate that the U.S. naval blockade has had ‘breaking point’ effects in two ways: 1) it has cut Iran off from most of its remaining hard currency earnings and 2) it is forcing the shutdown of Iran’s oil production which threatens lasting damage to at least some of its older producing reservoirs.  Both effects threaten the Iranian regime’s ability to sustain its internal enforcement capabilities and reconstitute its ability to threaten external actors such as Israel and its Gulf neighbors.  It also has depleted its own arsenal of weapons and munitions which will be hard to replace without hard currency.

This analysis suggests both sides found a ‘breathing spell’ to be essential from a timing point of view.  That said, it is hard to believe that the issues which led the U.S. and Israel to kill many of Iran’s top leaders and Iran to hold the world economy hostage are in any way reconciled.  It is not out of the question that Iran sees the need for a long interregnum to rebuild, but it is also hard to believe that this regime is surrendering its posture of hostility towards Israel, the U.S. and now its Gulf neighbors.  The agreement just reached is thus more in the nature of a truce than any sort of settlement.

Several questions arise from this analysis.  The first is whether the 60-day negotiating period is likely to bear any permanent fruit.  If the answer is ‘No,’ the next question becomes what will happen then.

Skepticism is warranted as to whether this deal is more than a temporary truce.  What would hold it together would be fear on Iran’s part that the U.S. & Israel, strengthened by the release of 60 days of Gulf oil supplies, would resume military action if Iran doesn’t comply with deal terms.  The alternative is that Iran uses the 60 days to rebuild its potential to threaten Hormuz and then dares President Trump to resume the war only 2 ½ months before the Midterm elections.  Such an outcome is possible. Indeed, given the regime survivors’ hardline makeup, it is the more likely case.

What will happen in the ‘failed truce’ case is devilishly hard to predict, but important clues can be gained by what the U.S./Israel and Gulf states do during the 60 days.  Obviously, fleets and crews need to be rested and arsenals re-stocked.  More important would new plans to preempt and/or counteract a new Iranian attempt to shut the Strait.  A short list of such plan components looks like the following:

• Precise intelligence on the Iranian locations used for potential new strikes on the Strait
• Rebuilt commercial inventories to withstand another supply disruption for some time
• Re-targeting an air campaign to focus almost exclusively on neutralizing Iran’s strike potential, combined, if necessary, with plans to seize Iranian islands on the north side of the Strait if this is essential to neutralize Iran’s threat capability.
• Perfected plans to protect private vessels willing to sail ‘dark’ through the Strait.
• Maximized Persian Gulf bypass capacity, i.e., pipelines, rail and truck logistics and other means to minimize the need to move crude, refined products and chemicals through the Strait
• Finalizing an ‘economic hostage’ target list, e.g. Kharg Island, that would be threatened to punish Iran for non-compliance with deal terms.

The war now ending showed that Iran has ‘one potent card’ to play, shutting Hormuz.  It is hard to believe that the U.S. and its allies would not be laser focused on neutralizing that card to give the deal every chance to hold and to overcome it if Iran decides it wants to play that card again.

The position of China in these events is also interesting. China’s interests are complicated.  It enjoys getting discounted oil from Iran and enjoys even more that country’s ability to distract America’s attention away from the Far East.  On the other hand, China has had to sharply reorient its economy to minimize the fallout from the war. China’s vulnerability to blockaded oil supplies is on full display. It also doesn’t enjoy being showcased as a non-player in these seminal events.  Taking China’s interests and cultural orientation into account, it would be reasonable to expect China to advise Iran to play a ‘long game’ – play along for now even if that means some concessions at the bargaining table; then, rebuild your military capacity and wait for the current U.S. players to pass from the scene.  China can sweeten this message with promises to help Iran to rebuild, cash to do so, and alternative pay mechanisms that make it less vulnerable to U.S. sanctions. Whether Iran will listen to such counsel is harder to predict.  Unless China’s offer of support is very generous, the Iranian regimes longstanding belief that it can out negotiate and out wait its U.S. adversary is more likely to prevail

This takes us to the last question – irrespective of whether this truce ‘holds’ for 60 days, what is the likely outcome thereafter?

A first point has been largely overlooked – that the coy neutrality of Iran’s Persian Gulf neighbors is probably at an end.  For the foreseeable future Iran will have that one card, shutting Hormuz, to play. That card strikes at the heart of the other Gulf states.  Thus, whatever their public stances, in private they will be working with the U.S. and Israel as regards preparations for another round of fighting.  For some that will mean creating or expanding their Hormuz ‘bypass capacity.’  It will be especially interesting here to watch Iraq and Kuwait who face the heaviest lifts required to create alternate export routes.  Other states, e.g., Saudi Arabia, will be concerned to protect their infrastructure, including their desalination plants, from renewed attack.  Since these countries cannot count on controlling whether the U.S./Israel will again attack, their next best alternative will be to rely on those states for a robust defense if worst comes to worst.  Intensive contingency planning among the U.S/Israel and these Gulf states will thus be a quiet backdrop to the 60-day negotiations.

Another less explored mystery concerns what happened to the internal resistance to Iran’s regime.  Masses went into the streets in January, and reportedly thousands died confronting the regime’s enforcers.  Clearly there was some expectation in Washington and Tel Aviv that the protestors would emerge again – the son of the long- deceased Shah was trotted out as an alternate head of state should regime change materialize.  When the U.S./Israeli attacks came, no masses poured into the streets.  Except for scattered accounts of Revolutionary guardsmen patrolling city streets with machine guns on motor bikes, almost no reporting conveyed what has happened to those who so visibly protested only a few months prior.  Was the regime so successful in decapitating the protestors’ leadership?  Were the crowds cowed by earlier arrests or the bombing going on around them?  Very little has surfaced on these questions.  Israeli intelligence, so recently praised for knowing when Iran’s leaders were at home in their kitchens, apparently didn’t know the true protest potential situation or else knew it but chose to downplay it as they worked with Washington in the walk up to February’s assault.

As for how the Agreement’s 60-day negotiating window will proceed, it is not hard to predict how Iran will play its hand.  It has one main bargaining chip, its enriched uranium stockpile.  It is overwhelmingly likely that Iran’s negotiators will try to sell, and resell, this chip for progressively higher prices – those prices being sanctions relief.  There are multiple technical matters surrounding this issue: when and how is the stockpile retrieved, is it diluted and kept in Iran or delivered intact to a third party, if the latter, which third party, what happens to Iran’s remaining centrifuges, and how are inspections conducted for how long?  This long list of ‘technical details’ gives Iran’s negotiators ample opportunity to eat up the 60-day clock with seemingly legitimate negotiations.  In fact, the more likely strategy shaping Iran’s tactics at the table is to test whether the U.S. has any more stomach for enforcement measures.  Already the U.S. media’s reaction to the deal’s preliminary announcement varies in a tight range – from a U.S. tactical retreat to an outright defeat in an unwise war.  Iran may well bet that Donald Trump will have even less stomach for resuming this conflict two months before Midterm elections than he had for continuing his militarily enforced blockade in June.

The hardest to answer question thus becomes what President Trump will do if/when the 60-day negotiations prove disappointing.  There are many unknowns in play here for precise prediction, but some general observations can be made.

First, however frustrating the conduct of the negotiations, the U.S. will see incentives to let them run their course; it may even find technical reasons to extend them.  Consistent with the idea that the present agreement is a ‘truce’ called for restocking and new planning, the U.S. and its allies may prefer having more time for global oil supplies and inventories to normalize.  It also will be interesting to observe the redeployment, or not, of U.S. military assets in the region.  Of particular interest will be whether the U.S. amphibious and ground forces return to home bases or not.

Second, the Iranians may overestimate the leverage provided by the coming U.S. Midterm elections.  President Trump may have already concluded that the GOP will likely lose the House of Representatives.  More weight will be given to retaining control of the Senate.  Should that prove likely, and normalized gasoline prices will help, the President will be less constrained by fears of either a House impeachment (very possible in any case) or joint congressional action to defund any resumption of military action.

A third piece of the puzzle will be the perceived efficacy of a second round of serious conflict.  Will the contingency planning cited above yield better prospects of keeping Hormuz open, of inflicting such new damage on Iran that it surrenders on the nuclear issue and/or of dividing the regime internally or exposing it to serious, resumed protests.  Positive answers to any of these questions markedly raise the prospects of the U.S. responding to failed negotiations with renewed military action.

A final element will be whether the Gulf states build out of their permanent bypass capacity.  This effort will take longer than 60 days; two years is a more reasonable estimate.  In the past, Saudi Arabia and the UAE made serious efforts of this nature while Kuwait, Iraq and Qatar did not.  Assuming they now reverse course and undertake those bypass pipelines, Iran’s hold over Hormuz becomes a ‘wasting asset.’  Completing the construction of region wide bypass capacity would greatly increase the prospects of a final showdown with Iran’s regime, presuming it survives and plays its hand as described above.

As of today, June 16, much of the commentary has concluded that the U.S. and Israel are unlikely to resume enforcement activities against Iran.  That might be the case.  More likely, however, this view is mistaken.  The fundamental issues dividing this Iranian regime from its neighbors, Israel and the U.S. are existential.  Little to no good faith characterizes their negotiations.  Intense planning to resume the conflict under more favorable conditions will be the backdrop to the negotiating theater that will command center stage.

Thus, what we have on our hands is hardly peace in our time but most likely a truce before another round of conflict.  As to the question of when, precise prediction is not now possible, but it can be said that if the Gulf states build out their bypass capacity, time will not be on Iran’s side.