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Vincent Lauerman

Vincent Lauerman

Vincent is president of Geopolitics Central, a Calgary-based energy consultancy. He has spent the majority of his three-decade career working as a global energy analyst.

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War With Iran Could Send Oil To $250

There has been much talk of an Iran War in recent weeks, but the likelihood of a war, whether intentional or accidental, is relatively small for the simple reason that the leaders of Iran and the U.S. don’t want one. President Donald Trump, who has been remarkably faithful to his campaign promises, to the chagrin of many, doesn’t want another Iraq-like war – with a quick victory followed by a long defeat. Ayatollah Ali Khamenei, Supreme Leader of Iran, doesn’t want his revolution and country crushed by the massive military might of America.

This is not to say there aren’t powerful individuals in the Trump administration – such as National Security Advisor John Bolton and possibly Secretary of State Mike Pompeo – and regional allies – Israel, Saudi Arabia and United Arab Emirates (UAE) – who want a war to bring about regime change in Iran, and who are willing to stir the pot in an attempt to make it happen.

Trump’s personal preference for Iran may also be regime change, with a negotiated neutering of the Islamic Republic his next best outcome. But he probably would settle for long-term containment of Iran through his “maximum pressure” campaign, accepting that the Iranian regime would likely be able to sustain itself though skirting sanctions.

Iran has made huge geopolitical gains in the Middle East since the U.S. inadvertently pushed Shiite-majority Iraq into the Iranian sphere of influence by imposing democracy on the country following the 2003 war. Tehran now directly or indirectly controls an arc of territory north of Saudi Arabia – Iraq, Syria and Lebanon – while supporting Houthi rebels to the south of the kingdom in Yemen.

Although U.S. sanctions on Iran’s oil and metal exports are unlikely to bring about regime change, they will make it significantly more difficult for the Islamic Republic to consolidate its territorial gains and sustain its regional proxy network, as the government will have to prioritize domestic spending to maintain social stability. Simply put, the sanctions make it more difficult for Iran to directly challenge its regional enemies, Israel, Saudi Arabia and UAE and score additional foreign policy victories.

Despite an aversion to war with the U.S., it appears Khamenei has given Qassem Suleimani, leader of Iran’s powerful Quds Force and national hero, permission to encourage foreign militias aligned with Tehran to cause mischief for U.S. and allied forces in the Middle East, and if possible, disrupt the flow of oil from the region through non-attributed actions.

The Iranian goal is to break the resolve of the U.S., given American military retreats from the Middle East in the past – Lebanon (1984), Iraq (2011), and Syria (presently) – and to increase the cost of Iranian oil sanctions on the global economy through additional disruptions to supply.

This is obviously a dangerous game that could lead to real war, not just proxy war. As a result, it is important to explore the potential impact of both on the world oil market, despite the latter being significantly more likely than the former.

U.S. Perspective

Pompeo laid out the Trump administration’s rationale and strategy for dealing with the Islamic Republic in “Confronting Iran,” an article in the November-December 2018 issue of Foreign Affairs. He argued the deal the Obama administration and international community struck with Iran in 2015 – the Joint Comprehensive Plan of Action (JCPOA) – was fundamentally flawed as it failed to end the country’s nuclear weapons ambition. Instead, the deal simply postponed Iran’s nuclear ambitions while the regime continued its ballistic missile program to allow it to deliver a nuclear payload.

At the same time, the deal gave “Tehran piles of money, which the supreme leader has used to sponsor all types of terrorism throughout the Middle East (with few consequences in response) and which have boosted the economic fortunes of a regime that remains bent on exporting its revolution abroad and imposing it at home.”

The core of the Trump administration’s maximum pressure campaign are economic sanctions designed to “choke off revenues” to Iran to force its government to negotiate a “new deal” covering its nuclear activities, ballistic missile program and “malign behaviour” across the Middle East, while providing sufficient military deterrence to keep Tehran from lashing out at U.S. forces and allies in the region.

Trump withdrew the U.S. from the Iran nuclear deal in May 2018, and has since ratcheted up economic sanctions on the Islamic Republic in August and November of last year, while going the full monty on Iranian crude and condensate exports at the beginning of May.

On the deterrence front, the U.S. has moved numerous military assets to the Persian Gulf region since the Trump administration’s “no waiver” oil sanctions came into effect. These include: hastening the arrival of a carrier strike group; deployment of a bomber task-force; additional Patriot missiles; and as reported by The New York Times, drawing up plans to send up to 120,000 U.S. troops to the Middle East, if Iran attacks U.S. forces or rushes to develop nuclear weapons.

It should be noted that a military buildup of this size would take months, and the 120,000 number is widely viewed as insufficient for a full-scale invasion of Iran. The Islamic Republic has been planning and building up asymmetric military capabilities to thwart a U.S. attack since the 1990s, while the country is larger in size and population than Iraq. The U.S. military plan reported by the New York Times did not call for a land invasion of Iran. Related: Who Is Winning The Offshore Solar Race?

On May 14, Trump denied the New York Times report, but in characteristic fashion appeared to up the ante. “Now, would I do that? Absolutely,” Trump said. “But we have not planned for that. Hopefully we’re not going to have to plan for that. If we did that, we would send a hell of a lot more troops than that.”

But in the Foreign Affairs article Pompeo wrote that Trump does not want the U.S. to go to war with Iran: “President Trump does not want another long-term U.S. military engagement in the Middle East—or in any other region, for that matter. He has spoken openly about the dreadful consequences of the 2003 invasion of Iraq and the 2011 intervention in Libya.”

Iranian Perspective

On May 14, Khamenei explicitly said that Iran does not want to go to war with the U.S., and suggested the same of America, as a war would be in neither country’s interest. "There won't be any war,” he said. "Neither we nor they seek war. They know it will not be in their interest."

In terms of Iran’s current situation, David Petraeus, ex-CIA director and America’s former top general in the Middle East, possibly put it best. "Certainly, if Iran were to precipitate that [a war], it would be a suicide gesture," Petraeus said on May 9. "It would be very, very foolhardy. And they know that."

The Islamic Republic has done an excellent job of marshaling relatively limited financial and military resources to expand its influence and control through the Middle East since 2003, but its defense budget of about US$16 billion – or a mere 3.7 percent of GDP – falls considerably short compared to regional rivals Israel, Saudi Arabia and UAE on an individual basis, let alone a collective one. The military capabilities of the U.S. dwarf those of Iran on every conceivable measure, which should come as no surprise since America’s most recent defense budget is a massive US$686 billion.

Khamenei also said his country has no desire to negotiate with the U.S., given the Trump administration’s extreme demands and unilateral breaking of the nuclear pact, and suggested the current crisis will likely be a long one, a view supported by Hassan Rouhani, the democratically elected president of Iran. “The Iranian nation has chosen the path of resistance," Khamenei said.

Rouhani was even more explicit. Speaking to activists from a wide range of political factions on May 12, he said Iran is facing “unprecedented” pressure from U.S. sanctions and suggested economic conditions may become worse than during the 1980-88 Iran-Iraq War. “The pressures by enemies is a war unprecedented in the history of our Islamic revolution,” Rouhani said, according to the state news agency IRNA. “But I do not despair and have great hope for the future and believe that we can move past these difficult conditions provided that we are united.”

The International Monetary Fund (IMF) is forecasting the Iranian economy to contract 6 percent in 2019, following a 3.9 percent decline last year, with unemployment to climb to 15.4 percent. In contrast, Iran’s economy surged an impressive 12.5 percent in 2016, after most global economic sanctions were lifted following the signing of JCPOA the year before.

Khamenei’s unwillingness to negotiate with the Trump administration, at least at the present time, should not come as a big surprise, as European diplomats and officials from past U.S. administrations say there are no grounds for serious negotiation. Tehran would see America’s current demands as “de facto surrender,” after a long line of geopolitical victories in the Middle East contributing to Iranian hubris.

Cat and Mouse

The Iranian leadership may not want real war, but it does want proxy war – a game of cat and mouse – against the U.S. and its regional allies to increase the cost of their anti-Iran policies in an attempt to break American resolve, while avoiding escalation to full-scale military conflict.

On May 16, The Guardian reported that Suleimani held a meeting in Baghdad three weeks prior where he told Iranian-backed Iraqi militias to “prepare for proxy war.” Knowledge of this meeting contributed to the U.S. government’s May 15 decision to evacuate non-essential staff from its diplomatic missions in Baghdad and Erbil and to raise the threat status at American bases in Iraq. It has since been reported that Iranian-backed militias elsewhere in the Middle East have been told to “await instructions.”

The most tangible actions of this so-called proxy war to date appear to be four ships – two Saudi, one Emirati and one Norwegian – being hulled off the coast of the UAE on May 12 in what Emirati officials have described as acts of sabotage near the port of Fujairah – 164 kilometers outside the Strait of Hormuz – and Houthi-rebels in Yemen using armed drones to attack two pumping stations of Saudi Arabia’s East-West crude pipeline two days later.

But Saudi state media has already called for “surgical strikes” by U.S. forces against Iranian targets in response to these transgressions. In an editorial titled “Iran must not go unpunished” in the Riyadh-based Arab New on May 16, the paper wrote: “The next logical step – in this newspaper’s view – should be surgical strikes. The US has set a precedent, and it had a telling effect: The Trump strikes on Syria when the Assad regime used Sarin gas against its people.” The Guardian reported that the Saudi leadership has specifically asked Washington whether it is planning to act to defend their interests.

The Iranian leadership also appears to be using the threat of restarting its nuclear program in their cat and mouse game. On May 15, state news agency ISNA reported Iran had officially stopped some relatively minor commitments under the 2015 nuclear deal, after notifying China, France, Germany, Russia and the United Kingdom of such the week before – and a year after the other signatory, the U.S., had unilaterally withdrawn from the pact.

In particular, Tehran is no longer planning to adhere to the nuclear deal’s 300 kilogram limit on low-enriched – 3.67 percent; compared to 90 percent for weapons-grade – uranium stocks and the 130 tonne limit on heavy water stockpiles.

Proxy versus Real War

As a result, while there are many possible outcomes, there are two extreme but plausible scenarios for Iran, the Middle East and the world oil market – Proxy War and Real War.

Under Proxy War, Iranian-backed militias in Lebanon, Syria, Gaza, Iraq and Yemen would ramp up attacks on U.S.-allied forces in the Middle East, while Iran and its proxies would launch sporadic missile and sabotage attacks on oil and gas infrastructure and tankers transiting the straits of Bab al-Mandeb and Hormuz. But their malign activities are constrained by two factors: U.S. and aligned forces hitting back hard in a disciplined fashion; and Iran’s financial difficulties significantly cutting funding and resources for their proxy forces. Related: California Threatens Gasoline Car Ban

In response to attacks and Iranian efforts to build up military assets in the Levant, the Israeli Defense Forces (IDF) would launch airstrikes on Hamas in Gaza, Hezbollah in Lebanon and Iranian-backed forces in Syria, while Saudi Arabia and UAE would boost their military activities to crush Houthi rebels in Yemen. By agreement, the U.S. will continue to patrol regional waters and respond militarily to any attacks to shipping and their armed forces in the region.

In this geopolitically-charged environment, the spot price of international benchmark Brent crude tends to average around US$85 per barrel, US$15 more than if Iranian oil exports were not constrained by U.S. sanctions, with occasional spikes above US$100 per barrel – despite continuing strong growth in U.S. oil production through the second half of the next decade.

The loss of roughly 2 million b/d of Iranian crude and condensate from the world oil market – cutting Tehran’s oil exports by about three-quarters – would drive spare capacity well below 1 million b/d, making crude prices more susceptible to supply disruptions, Iranian-inspired or otherwise.

Under Real War, the less plausible of the two extreme scenarios, Iran’s proxy war and related nuclear activities would be perceived as too much by Trump, especially after much nudging by hawkish advisors and regional allies. In March 2020, Saudi Arabia, Israel, UAE and the U.S. would launch a coordinated attack against Iranian aligned forces and assets in the Middle East.

In this scenario, the IDF invades Gaza and southern Lebanon to battle Hamas and Hezbollah, respectively, and launches massive airstrikes against Iranian military resources in Syria. Saudi Arabia, UAE and the U.S. launch airstrikes and missile attacks on Iranian military forces, oil facilities and major cities. Iran, and its proxy forces, respond in kind. Both sides refrain from a land attack, with the 120,000 U.S. troops stationed in the Gulf insufficient to launch a successful invasion of Iran but plenty to deter Tehran and its proxies. China and Russia call for an emergency UN Security Council meeting to condemn American-led aggression against Iran, but Britain, France and the US – the other veto holders in the council – nix a vote.

In six short weeks there is tremendous damage to oil facilities on both sides, given their proximity to the Persian Gulf region, and to major cities as well. Iran, with its fleet of fast patrol craft and arsenal of short-range rockets, is able to briefly close the Strait of Hormuz, disrupting the flow of about 18 million b/d to the world market, almost a fifth of global supply.

Brent spikes over US$250 per barrel, before falling back to around US$150 with the International Energy Agency (IEA) coordinating an emergency release of oil stocks from strategic reserves of its member countries and China releasing significant volumes from its now substantial strategic reserve as well.

Under heavy bombardment and with their military resources running low, the Iranian leadership calls for an end in hostilities and negotiations, which the U.S. and its regional allies immediately agree upon. Through negotiations a détente is achieved in the Middle East, with the two sides agreeing to demarcate spheres of influence in the region.

Saudi Arabia and the UAE agree to stop meddling in Iraq and Syria in return for Iran ending its meddling in Shiite areas of Bahrain, Yemen and Saudi Arabia. Lebanon is declared neutral territory. Iran agrees to mothball its nuclear program indefinitely and stop exporting weapons to its regional allies.

Once hostilities cease, it takes two or more years for the price of Brent to fall back into a US$60-70 per range – given necessary repairs to war damaged oil facilities in the Persian Gulf region and the rebuilding of global oil inventories – where prices remain indefinitely, capped by the spreading Shale Oil Revolution.

By Vincent Lauerman for Oilprice.com

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