There’s a major disconnect in energy market analysis. On the one hand, we have macro analysts looking at price charts, spreads, and momentum — thinking about energy prices as hedge funds do.

For instance, they compare NYMEX West Texas Intermediate (WTI) crude futures with Brent crude prices traded on ICE Futures Europe to identify relative-value trades. 

They also assume the Strait of Hormuz will reopen in “two or three weeks.” Of course, they’ve been saying two to three weeks for nine weeks. That’s getting old.

On the other hand, we have experts who are in the physical energy markets. They’re not traders. They own tankers, buy and sell cargoes, operate loading and unloading facilities, and run refineries. Some are government officials responsible for keeping the lights on and the factories running in places like South Korea and Japan.

These participants focus on one thing only — when the energy runs out, the lights go off. Data is no substitute for actual oil, natural gas, or refined products. 

What we’re hearing from the market analysts is relentlessly optimistic, with some allowance for short-term inflation. What we’re hearing from those in physical markets is dire and on the verge of panic. 

Those in physical markets have it right. They can’t pretend the way traders can.

Financial markets will adjust to the physical reality soon, but not right away. When it happens, financial journalists (usually the last to know) will call it a “shock.” But you can see it coming a nautical mile away. This analysis is your chance to look over the ridgeline and prepare for the so-called shock that’s coming.

The Double Blockade

The news regarding the Strait of Hormuz changes daily, sometimes multiple times a day. 

Iran has imposed restrictions on which vessels can enter or leave the Strait. It has also created a toll booth that will collect either $2 million per vessel or $1 per barrel of oil on a tanker moving through the Strait. 

This toll applies to what Iran regards as friendly cargo bound for China, India, and a few other destinations. Unfriendly cargoes headed to Europe or U.S. allies like Japan will still be blocked.

The U.S. has set up a blockade outside the strait. Once a vessel gets through the Iranian toll booth, the U.S. Navy will interdict it. If the cargo is from Iran and headed for China or another jurisdiction friendly to Iran, it will be seized. If the cargo is from Kuwait, Saudi Arabia, Bahrain, or the UAE, it will be allowed to proceed.

You can see the problem here. 

Vessels aligned with the U.S. cannot get past the strait in the first place. The U.S. Navy will seize vessels friendly to Iran. This double hurdle means that nothing will get through. 

Iran is behaving like a Mafia extortionist. The U.S. Navy is acting like Pirates of the Caribbean. No oil, natural gas, or nitrates — which are essential for fertilizer — are getting out of the Persian Gulf for the foreseeable future.

When the Pumps Run Dry

For the moment, let’s turn from geopolitics and look at how this will affect everyday Americans. 

We have seen energy shortages before in World War II, the 1973 Arab oil embargo, the 1979 Iranian oil crisis, and the 1987 tanker wars. Even as the rest of the world starts to run dry, the U.S. will not run out of oil this time. But the U.S. is not immune to the price impact.

The World War II generation is mostly gone, but the history of what they went through has been passed down. Here’s a summary of what to expect as gas hits $10 per gallon and the energy crisis drags on:

Rationing is the easiest and fastest method to conserve fuel. The government will simply dictate that drivers could have only, say, 4 gallons of gasoline per day, enough to drive about 100 miles in the average vehicle. 

This could be enforced in various ways. You might register your credit card so it would be recognized at the pump. Registered cards would stop pumping at four gallons. Unregistered cards wouldn’t work at all.

Another solution is the use of coupons. During World War II, U.S. citizens got a coupon book of paper certificates that could be used to purchase gas. Once coupons were exhausted, there was no more gas for you until the next coupon book arrived.

Today, the coupon book could be a government-issued debit card, similar to those used in the food stamp program. But it would work much the same way. Once your account balance is zero, you cannot buy gasoline until the government digitally replenishes the card’s balance.

A simple rationing method I experienced in the 1970s was to use the last digit of your vehicle’s license plate to determine when you could buy gasoline. An even digit could buy gas on even-numbered calendar dates, and an odd digit could buy on odd-numbered dates.

Some motorists got around this by having two cars with license plates ending with both odd and even digits. But it still limited how often you could buy gas. (I’m not sure how the government would handle vanity tags, but I’m sure there’s a way.)

Gas station attendants used to enforce this program. Today, some kind of scanner would be needed, but that’s not difficult to install.

When Policy Makes It Worse

Massachusetts lawmakers are looking to limit how much people drive statewide. This is ostensibly due to the Green New Scam, but the new oil crisis could give such an effort a boost. 

A more drastic approach is to implement price controls. Nixon, for instance, imposed price controls in 1971 in the same speech that closed the gold window. 

The U.S. could impose a cap of, say, $6.00 per gallon on gasoline alongside similar caps on diesel, propane, and natural gas. These controls would apply even if the world price edges closer to $15 per gallon, as it is in parts of Europe today.

Price controls sound good in theory, but they usually fail in practice. 

If energy companies can’t charge a market price, they will simply stop supplying the energy rather than lose money. This quickly turns a price problem into a supply shortage. But just because the idea is a bad one doesn’t mean it won’t happen. Politicians are known to do stupid things whenever a crisis emerges.

Another solution is to cut or suspend gasoline sales taxes. Depending on the state, this would lower the price of gasoline by $0.09 up to $0.71 per gallon in California. This works at the consumer level, but deprives states of tax revenue, which could create fiscal problems. 

Think of these possibilities as short-term solutions, but not real fixes. 

Inflation First, Recession Next

Of course, high gasoline prices at the pump are just one aspect of the global energy crisis. 

Most everything we buy arrives at a point of sale via transportation — whether ship, plane, train, or truck — that requires energy inputs. That means higher energy costs are embedded in the price of everything.

There’s no free lunch when it comes to energy costs.

The war in Iran will drag on, and energy-supply disruptions will last for months or even years. Higher prices will leave energy costs on a permanently higher plateau.

This makes inflation guaranteed in the short term — at least until reduced consumption of goods and services causes a recession and prices start to recede again. 

Still, this is a world of higher unemployment and stock-market volatility. Investors should prepare accordingly by reducing some equity exposure and increasing allocations to cash and gold.