The United States and Iran both say they want to avoid war. Even without one, the drama we've seen the last two months in the Persian Gulf still presents a threat to the global energy industry. That risk is incredibly under-appreciated by oil markets. Benchmark Brent crude prices are trading around $63 a barrel at the moment, which is lower than before the US-Iran crisis began. Traders remain more concerned about flagging oil demand stemming from a slowdown in the global economy than they seem to be about escalating tanker attacks.
Iran is the prime suspect in attacks on at least seven oil tankers near the Strait of Hormuz in the past two months. Ports in the Persian Gulf and even a major pipeline in Saudi Arabia have been targeted, and Iran shot down a U.S. drone it said violated its airspace.
President Donald Trump on Thursday said the USS Boxer shot down an Iranian drone aircraft that was threatening the U.S. Navy ship in the Strait. The latest escalation came Friday with Iran's Islamic Revolutionary Guard (IRGC) announcing it captured a UK-flagged oil tanker.
The Strait of Hormuz is the single biggest chokepoint for global energy trade. An estimated 20 million barrels a day of crude oil - or 20 percent of global supply - passes through the Strait.
Iranian leaders have said they are capable of closing the vital ship channel but that such a move would not be in their economic interest. Closure of the Strait of Hormuz would affect exports from Saudi Arabia, Kuwait, Iraq, United Arab Emirates, Qatar, and Iran. Some 26 percent of global LNG volumes, or about 110 billion cubic meters, went through the Strait last year, mostly from Qatar and the UAE. The area is home to multiple refinery and petrochemical export facilities as well.
While the media is fixated on the Strait because of its strategic economic importance, most investors believe its closure is unlikely - and certainly not a protracted one. The Trump administration is taking steps to guarantee the safe passage of ships through the Strait, including building an international coalition.
But there's more to worry about here than the possibility of a temporary closure of the Strait.
For starters, it's hard to see how this ends in a negotiated settlement, even if that's what Trump and Iran's leadership want to happen.
The United States has imposed the harshest sanctions in history on Iran through its "maximum pressure" campaign, measures that Tehran has called a declaration of "economic warfare." Trump has reduced Iran's crude exports - the OPEC member's lifeblood - to under 250,000 barrels a day. That is down from more than 2 million barrels a day before Trump withdrew the U.S. from the international nuclear accord in May 2018.
These are not the Obama-era sanctions, where Tehran was still allowed to export about 1 million barrels a day. Trump has vowed to reduce Iran's exports to zero, and he's having far greater success doing so than many thought possible. Even China and India, two of Iran's top customers, stopped importing Iranian oil entirely since May, when Trump revoked waivers. It's clear that even China and India, like their European counterparts, don't want to risk losing access to America's financial markets.
Tehran responded to the increased economic pressure by starting to violate the nuclear deal, which remains alive, if only just, with the Europeans. Iran has exceeded limits on the amount of nuclear material it can stockpile and is enriching uranium to slightly higher levels of purity.
Iran will continue to escalate its violations of the nuclear deal until it gets relief from sanctions. There's no indication President Trump plans to yield anytime soon. The most likely outcome in the near term is the continuation of the current stalemate, with Iran continuing to harass Gulf energy infrastructure as its only recourse against sanctions. Such incidents provide some support to oil prices in the current down market and allow Iran to generate higher revenues for the little amount of oil it manages to sell.
Iran's ability to cause trouble in the Gulf should not be underestimated. Tehran has proxy groups across the region. In Lebanon with Hezbollah. In Yemen with the Houthis, who are fighting Saudi Arabia and have already launched attacks on Saudi oil infrastructure and tankers. Iran also has close allies inside Iraq, OPEC's number two producer behind Saudi Arabia. Iranian proxies have twice forced Exxon to evacuate oil fields in Iraq.
What's next? Things are never so bad they can't be made worse. A corned Iran is a dangerous Iran. There's growing concern about the potential for attacks against offshore oil rigs, which could cause an environmental disaster. The risk of escalation is further complicated by Iran's reliance on unmanned drones, mines and cyberattacks to poke the United States from afar. Both sides are playing a dangerous game that neither seems to know how to end peacefully.
Oil markets may be optimistic for the moment but that confidence could yet prove to be misplaced.
