Credible Threats

Watching the progress of the confrontation over Iran's nuclear program generates more than a touch of deja vu for those who lived through the Cold War. This report from the Washington Post is full of the move-counter-move thinking that dominated strategic debates in the long US/USSR nuclear stalemate. Confining my focus to the energy risk implications, Iran remains the biggest--though hardly the only--risk in the oil market today. The state of play between Iran and the EU/US indicates it will be difficult to avoid realizing at least some of that risk, although it could still take a year or two to materialize.

While the larger issues of war, peace and international stability are certainly of interest, the question I'm most concerned with today is whether speculation about a military option against Iran's nuclear facilities, apparently based on leaked Pentagon plans, increases or decreases the risk of an oil market response by Iran. And while I realize that some of my readers are skeptical that Iran intends anything beyond building a civilian nuclear power system, we are in much the same pickle as we were vis a vis Iraq: Iran can't prove a negative, and its past behavior fuels the growing perception of unacceptable security risks.

The key point here seems to be separating the possibility of an actual military strike, which would have grave consequences not least on oil markets, from the threat of one--or at this point an implied threat--which could be a positive factor in reinforcing the diplomacy that provides the only realistic hope of defusing the present tension. If Iran believes the threat is hollow, they will be less likely to make meaningful concessions, while if they believe it is real, they might either give in, or be motivated to up the ante and threaten a preemptive oil embargo or export cutback. Nor is it far-fetched to wonder if their leadership might actually wish to be attacked, in order to solidify their control and maximize solidarity with the rest of the Islamic world.

The current administration didn't invent the practice of leaking information as a way of sending strategic signals. As a country, though, we don't seem overly adept at this, given the number of commentators and investigative reporters questioning the notion that we could actually pull off a strike on Iran's nuclear facilities. Note that I do not include in this the understandable denials of US and allied officials, who cannot be seen to endorse such an option openly. (This reminds me of a wonderful BBC series some years back about a crafty politician whose stock phrase was, "You might well think that; I couldn't possibly comment.")

At the same time, the demonstration in Iraq of our willingness to intervene when our interests seem to demand it now creates fear at home and abroad that we might attempt the same thing in Iran, while the Iranians--with their unique window on the Iraq conflict--could easily see it as a good reason why we wouldn't. So we're left with a presumed leak of an implied threat to attack Iran that is probably taken more seriously in Europe and the "blue state" sections of the US than it is in Tehran. Unfortunately, Middle Eastern leaders seem to be no better at reading our tea leaves than we are theirs, and if there's anything to the notion that wars start through miscalculation, then they could be setting up a classic case now.

So what does this mean for the price of oil? In my view, a favorable outcome--defined as one that avoids not only war but also an oil market crisis--depends on three essential elements, the resolve of the EU to carry through with sanctions if negotiations fail, the credibility of US force in the event sanctions fail, and an Iranian recognition that, in combination, these factors make the pursuit of their nuclear aims too costly. The current muddle around the effectiveness of a US military option should convince Iran that they don't need to throttle back oil exports preemptively, but it could also lure them into taking a harder line in negotiations, and thus increase the likelihood of a more serious confrontation later. That suggests the "Iran risk" for oil markets won't dissipate soon, though it probably won't turn into another price spike this year.