- More sanctions or export restrictions on Iran won’t affect the oil market materially.
- But the US could move to decapitate the Iranian regime’s leadership.
- It might even cause the entire regime to collapse.
- In such scenarios, military response from Iran could push oil to USD100/barrel and beyond.
- A US attack on Iran looks more a matter of when, not if. No wonder the oil market is tense.
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Commentary: Iran and oil
At a time when inflation pressures are easing globally, oil has the potential to be a spoiler. From food to energy, global supply/demand dynamic is highly favourable toward stable prices, precious and industrial metals being the only, and not very consequential, exemptions. But the manner with the US is ratcheting up pressure on the Iranian regime has made the markets nervous in recent weeks, pushing Brent crude past USD70/barrel.US intervention in Venezuela in early January proved to be not material, as it was restricted to the extraction of President Maduro, and has not yet led to any local conflagration that would disrupt Venezuela’s already modest oil production. But an existential attack on Iran’s regime could prove to be an entirely different ballgame. Consider the following scenarios:
- US, through tighter sanctions or outright attacks, constrain Iran’s oil production and exports. This alone would not be material as Iran’s exports are already down severely, taking it out of the top-50 ranking of global oil exporters.
- US moves toward decapitating the Iranian regime, which in response, lashes out, and begins attacking oil infrastructure across the UAE and Saudi Arabia, which account for a quarter of the world’s oil exports. Attempts are also made to close the Straits of Hormuz, the most critical energy chokepoint in the world.
- US intervention in Iran causes the regime to collapse; conflict and violence spread to all over the country, spilling over into Iraq and Syria.
Under scenarios (ii) and (iii), we would expect oil to head toward and likely past USD100/barrel. How long they stay there would depend on the depth of US and Israeli involvement to neutralise Iran’s military threats, but some of the damage done could take a long time to repair.
It could be argued that the massive mobilization of US naval assets on the Persian Gulf makes it unlikely that Iran will be able to pose any major threat to region’s energy infrastructure. Even if that is the case, a collapse of the Iranian regime with no on-the-ground intervention by the US, which appears to be very much to be the plan, could cause civil war-type conditions and widespread regional spillover, with attendant risks to energy production and exports.
Even a last moment reprieve from immediate attacks may not soothe the oil markets. The Trump administration seems keen to attack Iran, demanding concessions it simply cannot deliver. An attack, in our view, seems to be a matter of when, not if. The ongoing rise in oil prices, despite ample supply in the market, is a clear illustration of the conflict risks and their aftermath posing major upside to energy prices, adding an unwelcome risk to an otherwise benign inflation outlook.
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