You don't need me to tell you that conflict and instability in the Middle East remain primary reasons that oil is over $70/barrel and gasoline at $3.00/gallon in the US. The full implications of the war in Lebanon are less clear, however--particularly in its latest phase, with a mini-ceasefire in the wake of the bombing by Israel of a civilian shelter in Qana. Although neither Lebanon nor Israel exports oil, the possibility that the conflict could widen to include Hezbollah's sponsor, Iran, was enough to send oil markets up by about $4/barrel initially, though they have cooled since. How could the resolution of this crisis affect the future trajectory of energy prices?
The worst outcome would be a rapid spread of the present conflict to the entire region, sparking a broader Middle East war, or even a world war. However, in an op-ed in Sunday's Washington Post, the British military historian John Keegan comprehensively demolished the analogies between Lebanon and the events that started World War One. But even if the entire region is unlikely to go up in flames as a result of the present hostilities, that doesn't rule out some very serious consequences for energy. Mr. Keegan reminded us of the possible use of oil prices as a point of policy leverage. I don't see how that can be ruled out here.
A more realistic prospect is a stalemate favoring Hezbollah, with their mere survival being tantamount to victory. Whatever its military successes, Israel is losing the PR battle, and that could trump its air and ground power. Any resolution that preserves the status quo ante would embolden Iran and strengthen its nuclear program. If the outcome in Lebanon further undermines the solidarity of the West in this regard, or makes Iran less willing to negotiate, then it may calm the region in the short run, but it will elevate the likelihood of a more serious confrontation later. It would also increases the chances that a military solution might be attempted, a la Osirak. This is where the risk of a cutoff of Iranian oil exports rises to a near certainty.
The UN plan put forward by the US and UK looks like the best chance for neutralizing the Lebanese front and, indirectly, for keeping the heat on Iran. It would at least remove this latest threat to the region's stability and push the chances of wider war down by several notches. That ought to deflate some of the oil market risk premium, perhaps taking us back to the $65-ish level we were at only a few months ago. From there, improving fundamentals could push prices even lower. I will be more optimistic about this possibility when countries actually start volunteering to join the proposed international buffer zone force.
In the meantime, none of us enjoys having the price of energy held hostage to the unpredictable politics of a region that has known little peace in the last 50 years. The most important energy implications of this situation may well lie in the way it bolsters the energy security argument for renewable and other domestic sources. If Lebanon is a "recruiting poster" for Islamic extremists, it may also turn out to be one for American "Geo Greens."