Iran, Iraq and Suleimani: How will things play out for energy markets?

It’s winter in Baghdad, but the US killing of Iranian major general Qassem Suleimani and Iraqi militia leader Abu Mahdi Al Muhandis has raised the already heated political temperature. The complex crisis in Opec’s second-largest producer has not affected oil output yet, and the market continues to have reasons for complacency. But if Iraq becomes a battleground, this will not sustain.

As Charles de Gaulle is supposed to have said, the world’s cemeteries are full of indispensable men. Suleimani, however influential and able, will be replaced, and Iran’s policy and capabilities will not change much. With Suleimani alive or dead, Tehran has to escape the noose of sanctions. It has repeatedly kept the US off-balance, the American response swinging between uncalibrated hostility, bluster and timidity.

Washington’s campaign against Iran has hinged on economic pressure, without a diplomatic strategy backed by measured force, whether in Iraq, Syria, Yemen or Lebanon, where Suleimani operated with such deadly effectiveness. The past decade’s flood of shale oil has encouraged the US to target not only Iran’s oil exports but also Venezuela’s, confident that it can cover any shortfall. But this approach floats unspoken on the oil of the Arabian Gulf, including Iraq’s.

Between the 2014 and 2019 price slump, Iraq increased oil production more than any country in the world except the US, about 1.4 million barrels per day. Meanwhile, Iran’s output slumped under the pressure of sanctions, but the market remained oversupplied. Oil prices did not escalate to levels that would have made Donald Trump politically uncomfortable.

The massive protests against sectarianism, foreign influence, corruption, unemployment and misgovernment that have swept Iraq since October have not interrupted its oil industry, apart from a brief shutdown of the Nassiriya field and refinery, and minor output from the northern Qayyarah field.

Exxon Mobil, the only US oil company operating outside the Kurdistan region, had already evacuated most of its expatriate staff, and withdrew the remaining 18 on Saturday. Its protracted negotiations for the crucial water injection project to support reservoir pressure at the southern Iraqi fields will probably now come to a final halt. Other companies are also removing their American personnel, but the Iraqi workforce will continue operations.

Imagine how things could unfold from here? A scenario that could play out is that the killing of Muhandis, more than of Suleimani, makes it impossible for the Iraqi prime minister, either Adel Abdel Mahdi or his successor, to resist demands for the 5,000 US military in the country to leave.

Americans could then attempt to retain a presence in the Kurdistan region, but Baghdad cuts off Erbil’s budget allocation, and in response the Kurds stop transferring 91,000 bpd of federal oil from Kirkuk. The remnant US presence in north-eastern Syria, dependent on logistical support from Iraqi Kurdistan, also becomes untenable.

The Opec+ coalition is slow to move on relaxing its deeper production cuts, preferring to reap the rewards of higher prices, though Russia and Saudi Arabia do put more oil on the market. The Saudi-Kuwaiti Neutral Zone is restoring its 0.5 million bpd capacity only gradually towards the year-end, after the deal between the two countries.

Iran uses sabotage and protestors to harass western-run oil operations in southern Iraq, and its agents attack American people and assets throughout the region. It casts off all limits on its uranium enrichment.

The US responds with further strikes against Iran-allied forces in Syria and Iraq, but escalates to attack Iranian Revolutionary Guard targets within Iran, and uses its navy to interdict all oil and petrochemicals shipments out of the country.

As they did at Abqaiq in Saudi Arabia in September, the Iranians launch drones and missiles at key energy infrastructure and tankers in the Gulf and Red Sea. The vulnerable Iraqi export infrastructure, with leaky pipelines adjacent to Iranian waters, is easily shut down by an apparent technical failure. These actions are more consequential and harder to counter than the long-feared but simplistic idea of a blockade of the Strait of Hormuz.

Shale was expected to ride to the rescue in the event of a major disruption. But American drillers are newly cautious, preferring to use higher prices to reduce debt and pay dividends to impatient shareholders. The increasingly dominant supermajors do not adjust their budgets swiftly. After several months of elevated prices, shale producers do increase activity, but take months to yield significant new production. Electric vehicles suddenly look a much better choice.

In such a situation, the US would normally release oil from its strategic reserve. But at first, Mr Trump holds this back, touting US “energy dominance” and “freedom molecules”, and demanding others pay up before it will unilaterally protect Gulf oil shipments.

The spike in oil prices takes its toll on already shaky world demand. China, which gets 43 percent of its petroleum imports from the Gulf, has to act, dispatching tanker escorts from its base at Djibouti, and attempting to establish another at Gwadar in Pakistan. In return for its not entirely altruistic support, Mr Trump eases trade pressure.

Following the encouragement of December’s joint Iran-Russia-China naval exercises in the Gulf of Oman, Moscow also sees an opportunity to insert itself further into Middle East affairs. As US pump prices escalate towards a November election marked by mysterious cyber-interference, and the fighting undermines his promise to bring the troops home, Mr Trump jumps at a Sergey Lavrov-mediated ceasefire.

Relative peace returns to the region, and oil facilities are repaired over the next couple of years. The US does not leave the Gulf, but it is no longer an American lake, while the regime in Tehran gains prestige just from surviving. The 2020 sun sets on a very different and contested political and energy landscape.

Robin Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis