It was said of terrifying West Indian fast bowler Patrick Patterson that, if even he didn’t know where the ball was going, the batsman had no chance. The US administration may have yet to decide what to do with its armada off the coast of Iran. So neither the Iranians nor energy markets know quite how to respond.
Oil prices rose above $70 per barrel on Thursday for the first time since last July, when the US was applying pressure to both Iran and Russia with tightened sanctions. Despite the “glut” narrative for this year, prices have been supported by temporary factors: the interruption to US output caused by winter storms and a sharp drop in Kazakh supply because of fires at the key Tengiz field.
European natural gas prices rose sharply last month, because of prolonged cold weather and the depletion of storage. The US freeze has not helped. The White House’s geopolitical threats make Europe wonder if it has escaped the frying pan of dependence on Russian pipelines for the fire of over-reliance on US liquefied natural gas (LNG).
As the USS Abraham Lincoln loiters near Iran, President Donald Trump posted: “The next attack will be far worse! Don’t make that happen again."
But Ali Larijani, secretary of Iran’s national security council, in Moscow for talks with Russian President Vladimir Putin, countered: “Contrary to the hype of the contrived media war, structural arrangements for negotiations are progressing.” Tehran announced a live-fire military exercise in the Strait of Hormuz, while several explosions in the country were explained away as due to gas leaks. The UAE, Saudi Arabia and Qatar have each advocated diplomacy rather than war.
Possible outcomes
There is a range of possible outcomes from the current confrontation. It might end in nothing, or in some US military strikes targeting missile or nuclear sites that do not affect Iran’s energy industry, as in the brief war last June.
The US and/or Israel might attack domestic Iranian energy infrastructure, concentrating on gas, electricity and fuel distribution. There were some hints of that in last June’s hostilities. After Iran’s brutal suppression of protests last month, Washington might wage a lengthier military campaign, or a blockade of oil exports, in an attempt to bring down the regime or destroy it as an effective threat.
Iran could strike back in kind, as it did last year when it seriously damaged a refinery in Haifa, Israel. It might attempt to damage Israeli offshore gas installations, also crucial for supplying Egypt and Jordan. It might also try to hit regional energy infrastructure, even if the often repeated threat to “close Hormuz” is exaggerated.
Conversely, in the event of being attacked, Tehran might strike a deal, perhaps after a reshaping or decapitation of its leadership, as Israel also tried last year, and as the US did in Venezuela on January 3.
With such uncertainty, it is not surprising that energy markets are unsure how to react. The situation contrasts with that in Venezuela at the start of this year. That was a one-way bet: the Bolivarian Republic’s diminished oil exports could really only go up.
Iran is mostly a bet in the other direction. Its oil exports have been strongly on the up since 2022. Reaching 1.5 million to 1.7 million barrels per day of crude and condensate, and 0.5 million bpd of refined products, an interruption would be big enough to drive prices $15 per barrel or so higher.
However, Opec's spare capacity, mostly in Saudi Arabia and the UAE, is more than enough to compensate. China, Iran’s biggest customer by far, could cut back on filling its strategic stocks, or take more discounted Russian oil in replacement.
Despite Iran’s being the world’s third-biggest gas producer, it exports rather little. Its main customer, Turkey, has alternatives, including stepping up LNG purchases – which would tighten the global market – or buying more Russian gas, which would not.
The low-probability but high-impact risk is therefore of damage or interruption to Gulf energy production or transit. Trying to close Hormuz entirely would be temporary and near-suicidal for the regime in Tehran, therefore would be a last resort.
But there are other options for retaliation. The Houthi forces in Yemen have shown how effectively a few missile, drone and mine attacks could chase ships away from a crucial waterway. A similar campaign in the Gulf would not halt LNG and oil transit, but would limit it and sharply raise shipping and insurance premiums.
In the case of a deal with the US, things look different. The risk premium would evaporate. An easing or suspension of sanctions might boost total Iranian output to about 3.8 million bpd, bringing back 300,000 to 500,000 bpd of its exports. If it could sell to customers other than China, discounts and expensive use of the “shadow fleet” and sanctions evasion would end, saving it at least $8 to $10 per barrel.
Iran's ageing fields
Iran’s fields are technically an easier proposition than Venezuela’s sticky crude. But any detente with Washington and its Gulf neighbours, or a new, more open governing system, would not bring a surge of Iranian oil production. Even in friendlier political climates, Tehran has never been an easy place for international oil companies to work.
Its ageing fields need heavy investment merely to stem natural declines and it is short of gas to inject for crucial improved oil recovery projects. Under favourable conditions, output of 4.5 million barrels per day by 2030 is plausible, a moderate but not game-changing boost.
So geopolitical risk certainly seems skewed towards higher oil and gas prices. Conversely, if peace is achieved in the Arabian Gulf or the Caribbean, the market will be looser but not dramatically reshaped. For now, none of the players quite know what they want, or what they will do next.
