Iran War Scenarios Updated

How long will the war with Iran last and what will happen to energy prices in the coming quarters?   

Figure 1: Iran War Scenarios and Oil Prices        

 ·       Source: Continuum Economics.  Other scenarios are less than 5% e.g.  Collapse of regime/Civil War and move towards free election or IRGC overthrowing clergy.

 We are fine tuning our Iran war scenarios (Figure 1).  The U.S. on balance is heavily biased towards a 4-8 week war, both as high gasoline/diesel prices risk the GOP losing the Senate as well as the House in November mid-term elections and as Trump strong bias is against long wars. Trump threat March 21 to bomb Iran’s power plants and then subsequent decision to postpone for at least 5 days is consistent with this 4-8 week war view.  The one issue is that Trump does not like the image of him losing and so any end to fighting will be declared a victory for PR spin.  Israel would likely stop attacks on Iran with the U.S. end of military strikes.  Israel could have an election as early as May and Netanyahu claims Iran nuclear capabilities is crippled.  However, Israel has signalled it would likely continue the war with Hezbollah.  Iran is the key swing factor between a 4-8 week war and 2-6 month war.  Iran is asking for U.S. and Israel commitment against future attacks or they will continue the asymmetric war against energy and effective closure of the Straits of Hormuz.  However, Iran has suffered severe damage to conventional military offense and defence and is vulnerable to its shipping/exports being stopped e.g. Blockade or invasion of Kharg island.  On balance, Iran will likely accept an end to hostilities rather than fighting on.  We thus feel that a 4-8 week war is the highest probability, but this is unlikely to see a formal ceasefire with concessions (see below). The scale of energy infrastructure damage is also a further consideration for future energy prices and economic effects.  We highlight below the two main scenarios that could occur, with some broad estimate of probability – with the understanding that these will likely change based on decisions in Iran/U.S. and Israel.     

·       4-8 week war (65%).  Military and state infrastructure damage in Iran sees Iran authorities stopping the war alongside the U.S. This could involve no formal ceasefire, as Trump PR instincts mean he wants to claim victory without concessions. This could occur in the next 1-2 weeks or Iran could drag it out until mid-April to try to get concessions from Trump.  If no ceasefire agreement is reached then the U.S. will likely try to reach an informal understanding with Iran that the Straits of Hormuz should open to most shipping, as an act of goodwill on all sides. This would still be a fragile post war environment, with a risk that it could see a restart to the war.  This could keep demand higher than normal and slow the decline in energy prices.  However, it is feasible that the Trump administration could give a commitment not to attack over a specified period that could be enough for Iran to agree a formal ceasefire and allow the Straits of Hormuz to fully reopen – Israel would likely not agree to not attack in the future, but Iran would hope that U.S./GCC pressure would curtail Israel.  If a ceasefire is agreed then the Straits of Hormuz shipping could recover more quickly and energy flows help to reduce the oil risk premium by mid-year.  On balance, we go for a no formal ceasefire agreement and we would see WTI at USD75-80 by end June and USD65-70 by end December.

·       2-6 month War (30%).  Iran fights on against U.S./Israel targets in the region, as U.S. reluctant to make concessions to Iran and Iran wants to force agreement on no future wars.  Iran could use drones for many months to cause mid-level problems around the region and effectively close the Straits of Hormuz.  The U.S. proposal of a naval escort without a ceasefire would be dangerous, as the effective channel is 4kms for oil supertankers and closer to the Iranian shoreline!   War lasts months rather than weeks, which then leads WTI oil prices to USD120-180 (wide range reflects uncertain over length of 2nd scenario and further energy infrastructure damage) as oil exports through the straits of Hormuz remain heavily restricted and strategic oil reserve release is insufficient. Though IEA countries have released 400mln, the estimated loss excluding redirected via pipeline is around 11-16mln of crude oil and products per day.  China is starting to release some of its huge commercial stockpile, but is reluctant to rundown too far. Oil reserve release works for a 4-8 week war, but not a 2-6 month effective closure of the Straits of Hormuz. Oil prices would thus have to rise to cause some demand destruction around the world.  This scenario could also involve some more lasting damage to oil and gas production facilities in the region. Could see escalation with U.S. invasion of Kharg island and Iran attacking more energy facilities in the region.  Eventual end to the war, but with very fragile situation meaning oil prices come down but risk premia would be higher than the 4-8 week war scenario above.  We would see WTI at USD120-180 by April/May and USD80-110 by end December, as excess of demand over supply would spill over the whole of 2026.  

Figure 2: Iran War Scenarios and WTI Oil Price Projections         

Source: Continuum Economics. 

Natural gas prices outside the U.S. will be elevated for longer, with 17% of Qatar LNG export facility damaged for 3-5 years.  Under a 4-8 week war, some gas flows in Q2 would resume and we forecast European TTF at Eur55 for end Q2 and Eur48 for end Q4.  This has an important impact on Asia and Europe economies.