Posted: Jun. 28th 2019
Iran: Increasing Tensions
Recently, there has been a dramatic and concerning escalation of tensions between the United States and Iran. Several weeks ago, four tankers were attacked off the Emirati coast. These tankers were damaged by explosions that took place within UAE territorial waters off the Port of Fujairah. Last Friday two tankers were attached and damaged in the Gulf of Oman. The recent attacks were accomplished using limpet mines – a type of naval mine that attaches to a ship’s hull magnetically and may be detonated remotely or by a timer. The initial assessment by the United States was that these attacks were carried out by Iran or groups backed by the Iranian government.
There can be little doubt these recent events represent a serious escalation in an already unstable region. Tensions have been steadily building since the United States unilaterally withdrew from the Iran Nuclear Deal. At the time of its withdrawal, the stated policy of the United States appeared to be the application of maximum economic pressure on Iran to drive it back to the negotiating table in order to conclude a “better” (more onerous agreement). President Trump stated unequivocally on numerous occasions publicly that his view was that the Iran Deal was a “bad” deal and needed to be renegotiated. The re-imposition of U.S. sanctions, as expected, has negatively impacted both the Iranian economy and crude oil exports. However, United States policy towards Iran has been bi-polar with certain members of the Trump Administration threatening further sanctions and potentially military action while President Trump has been offering to engage in direct talks with Iranian leaders without preconditions. Last week Prime Minister Abe of Japan went to Iran attempting to mediate discussions between the parties. The discussions were cut short by the most recent attack in the Gulf of Oman. Iran’s supreme leader (Ayatollah Ali Khamenei), however, rebuffed, Prime Minister Abe’s overtures stating that discussions with the U.S. would be fruitless after its unilateral withdrawal from the Iran Nuclear Deal and the re-imposition of sanctions. In short, presently there is little to no trust left between the parties.
To date, there has been little policy coordination between the United States and its traditional allies regarding Iran. The signatories to the Iran Nuclear Deal (UK, France, Germany, Russia, and China) remain bruised by the Trump administration’s unilateral withdrawal from the Nuclear Deal which allies believe was working – albeit imperfect. Moreover, these allies are reticent to support the United States in hopes of somehow preserving some or all of the old agreement. There is a growing concern amongst allies of the United States that a mistake, misunderstanding or inadvertent action by either party might ignite a regional war. This is the possibility United States allies, as expected, are desperately trying to avoid.
This week Iran has decided to up the stakes by announcing that it was only 10 days away from breaching the uranium stockpile limits contained within the Iran Nuclear Deal. Under the Nuclear Deal Iran was required to keep its stockpile of 3.67% enriched uranium under 300 kgs. These and other limitations were put in place to dramatically decrease Iran’s ability to build a nuclear bomb and increase its “break-out time” – time need to rush to make a bomb, to more than one year. The announcement if carried out would dash France, Germany and the United Kingdom’s hopes of maintaining the old agreement and force them to choose sides.
There can be little doubt that the situation between the U.S. and Iran is growing more serious by the day. In response to the recent attacks on tankers, President Trump is sending additional troops to the region to join a carrier strike group which was sent several weeks earlier. The likelihood of negotiations between the parties appears to be shrinking with each passing day as the economic cost to Iranians continues to grow and the current regime digs in its heels fearing the United States intentions are truly aimed at regime change. The Iranians appear to be banking on the fact that the United States does not currently have the full support of its allies, or the international community, and therefore is unlikely to take unilateral military action. This is clearly a calculated risk. Presently it is extremely hard to predict who will blink first in this extremely dangerous contest of wills.
To date, the impact of these escalating tensions on the global energy markets have been muted. Although the list of conditions supporting the bull case for oil prices is extensive – (i) growing tensions in the Middle East, (ii) attacks on tankers in the Persian Gulf, (iii) sanctions throttling crude exports from Iran, (iv) production/exports collapsing in Venezuela due to political turmoil, and (v) exports from Libya decline due to continued internal political conflict – prices are roughly flat since the start of the year. The reason prices have not increased sharply as one would expect under these circumstances (i.e., rising geopolitical risk and restricted supply) is that the market has trained its focus on the demand. Over the past several months, the market has become increasingly concerned about global economic growth. The trade war between the United States and China has significanly slowed growth in both countries. Moreover, Europe continues to struggle with both political and economic structural issues (including, but not limited to, Brexit) which are dampening any hope for a return to growth. These concerns have been accentuated by statements made by major central banks that increased stimulus may be required in the near term to support major economies.
As we have stated before, in the near term the only foreseeable support for the market is a geopolitical event impacting the production and/or flow of crude oil or a swift conclusion to the United States / China trade war. In the case of the latter, we would expect this to result in a short-term pop in the market which will gradually bleed away as the market begins to understand the real lasting impact of the trade war and parameters of any agreement between the world’s two largest economies.