Last week's increase in crude oil prices seems to have had more to do with the fundamentals of supply and demand, than a change in perceived geopolitical risks. But while estimates of US demand growth have sent the oil market up and down over the last several months, tensions with Iran seem to be moving in only one direction. The Islamic Republic's pursuit of nuclear technology remains the headline issue, and the UN Security Council has just unanimously agreed to tighten sanctions, but the more immediate worry is Iran's seizure on Friday of 15 Royal Navy and Marine personnel. Although a similar crisis was resolved peacefully three years ago, it illustrates the heightened risk of miscalculation created by the proximity of one potential crisis to an another, active one.
Although the experience of pre-war intelligence on Iraq has taught us all caution, the pattern of Iran's nuclear activities makes the most sense as a program to develop nuclear weapons. Diplomatic efforts to block this path have been agonizingly slow, and the lowest-common-denominator sanctions that we and our European allies have pushed through the Security Council may seem timid to some, compared to the proliferation risk involved. However, they are starting to bite, and even Russia is chipping in with some useful commercial pressure. President Ahmadinejad doesn't look quite so formidable as he did a year ago, notwithstanding the doublespeak coming out of his foreign ministry. His position could grow even more tenuous, once Iran starts rationing gasoline. Years of heavily-subsidized gasoline prices have created more demand than the country's refineries can meet, and this is consuming precious hard currency. In this context, sustained diplomatic pressure to contain Iran's ambitions is no longer just a means of buying time; it now looks like our most promising option.
However, as long as we're fighting next door in Iraq, the downside of this approach is that it will keep generating opportunities for one side or the other to make a tactical miscalculation that could spiral out of control. Whether the orders to seize the two British patrol boats came directly from Tehran--as a tit-for-tat reprisal to the US arrest of suspicious Iranian "diplomats" in Baghdad--or from an overzealous local commander, the Iranians are playing a dangerous game. I'm not familiar with the rules of engagement under which the Coalition forces in the Persian Gulf operate, but it's not hard to imagine a different outcome to this incident, if Coalition naval or air support had been a little closer to hand, or a trigger finger on either side slipped. With both sides on edge, this sort of behavior a recipe for disaster, and I hope that message is being conveyed to Iran's diplomats in the strongest terms.
Too much of the world's oil transits those waters to take this risk lightly. Although the Persian Gulf "tanker war" of 1984-87 failed to halt the overall steep slide of oil prices at the time, the market today is tightly enough balanced that it wouldn't take much to send prices back to last summer's record highs and beyond. That might benefit Iran in the short term, increasing the value of its exports, but I suspect they'd soon find that oil weapons, like nuclear ones, are more effective as long as they remain in the realm of threats and uncertainties. The last thing the mullahs should want is to teach us how to do without their oil.