Days of Uncertainty?
Uncertainty is high over Iran’s response to the killing of Soleimani. Worst case is a high profile strike against U.S. assets in the Middle East (military or civilian) that prompts a disproportionate response from President Trump. It is more likely that a measured response will be seen from Iran due to a number of factors.
- Unpredictable Trump. The U.S. President has shifted from little response to the Iran-backed attack on Saudi oil facilities in September 2019 to an aggressive move against Iran’s top foreign commander. Some will argue that the U.S. patience broke, while others will point out that this is classic Trump engineering a distraction with the Senate impeachment trial due to start—Clinton attacked Iraq in 1998 with impeachment hearings due to start. Either way, Trump’s future decision-making cannot be confidently guessed by Iranian leaders, which tends to point to a calibrated response rather than an aggressive response. Trump does not want a war, but is happy to tactically stand up to Iran. The U.S. military superiority is also a key issue, as an aggressive Iran response could see military targets attacked in Iran by the U.S.
- Iran’s long game and economy. The Iranian leadership has typically played a long game by trying to maintain the regime. George W Bush’s post-9/11 Afghan and Iraq wars prompted Iran to de-escalate and suspend its nuclear program. Additionally, Iran’s economy is suffering from the renewed U.S. sanctions, with the IMF forecasting a 9.5% shrink in the economy in 2019, partly given widespread protests in Iran during November. Iran does not want a war with the U.S.
- Russia’s and Turkey’s reluctance. While Russia and Turkey are willing to occasionally cooperate with Iran, both countries are more interested in expanding their own influence in the Middle East rather than getting drawn into a U.S./Iran conflict. Russia and Turkey will likely take advantage of any Iranian weakness in Syria and potentially in Iraq.
A calibrated response from Iran will likely have four elements. First, attack via proxies. This could involve some form of incident in Syria, Yemen, Iraq or against Saudi facilities, but perhaps not on the scale of the September 2019 attack on Saudi oil facilities. Second, an attack on oil tankers in the Strait of Hormuz. Iran could also harass or attack shipping coming from Saudi Arabia to push oil prices higher on a temporary basis and also attract a lot of PR in the West over the risk of higher fuel costs and hence pressure Western politicians. This will likely stop short of a blockade and is likely to follow the pattern seen in 2019. Third, the threat of accelerated uranium enrichment. Iran has already signaled over the weekend that it will suspend all limits on uranium enrichment and remove all curbs on the number of centrifuges in operation, which will increase fears of nuclear weapons’ capability in the future. However, Iran has not completely ended the 2015 agreement and will cooperate with the UN international atomic energy agency. This suggests that current Iran action may only be temporary. Finally, cyberattacks. Iran has capabilities to attack U.S. commercial interests via cyberattacks, but this would need to be measured as the U.S. capabilities are greater.
Financial Market Nerves
If the Iranian response is measured, then it will likely only see a modest further retaliation from the U.S. Trump’s motives are mixed and potentially transitory. Additionally, the U.S. would also want to maintain troops in Iraq to avoid a new Iraq civil war and allow Iran or ISIS to capitalize on the vacuum. On balance, financial markets’ worst fears are unlikely to be realized.
Indeed, looking at back month oil prices, the reaction has been more limited than spot prices, as the oil market sees this as a temporary geopolitical risk and supply threat. The fundamentals of the oil market in 2020 still remain that new supply in the U.S. will be supplemented by fields in Brazil and Norway, which should push oil prices lower in H2 2020. We still stick with our forecast of $55 WTI by end 2020.