Dissatisfied with the Iran nuclear deal signed under the Obama administration, Trump terminated U.S. participation in the Joint Comprehensive Plan of Action agreement in 2018 and has since imposed maximum pressure sanctions on Iran. Most importantly, these sanctions have seen Iranian crude oil exports fall from around 2.5 million barrels per day (mbpd) to as low as 0.1-0.2 mbpd this past summer. Even during the height of sanctions prior to the nuclear deal, Iran was allowed to export approximately 1.1 mbpd.
Maximum sanctions has led to considerable hardship within Iran. Oil exports of 2.5 mbpd bring in 40 percent of Iranian government revenues. On the spending side, Irans national budget allocates 15 percent to defense and 85 percent of other programs like pensions, healthcare, subsidies, education and infrastructure. The collapse of oil revenues, combined with the effect of sanctions, has prompted the Iranian government to reduce or defer some outlays, as well as paying the bills by printing money. Officially, inflation has risen to 43 percent, and the cost of food and medicine has soared 40 percent to 60 percent, according to European Union figures. As a result, some Iranians are no longer able to afford fresh food, and many in middle-class neighborhoods in Tehran have resorted to buying withered cucumbers and rotting tomatoes, grapes, apples and peaches that grocery store salesmen put aside every day at dusk, reports the Los Angeles Times. Notwithstanding, in an economy facing collapse, housing prices have doubled, according to the Financial Times. This kind of hyperinflation is usually consistent with aggressive money printing by the government in an attempt to pay its bills in the absence of revenues oil revenues in this case. Irans situation is all but untenable.
Tehrans options are limited. The government of Iranian president Hassan Rouhani is not prepared to accept US conditions, but neither can Iran defeat the U.S. militarily.
The White House believes sanctions will break the Iranian government. Secretary of State Mike Pompeo has stated that Irans GDP could shrink by 12 percent to 14 percent, which is about the contribution of Iranian oil exports to the countrys GDP during normal times.
Alas, sanctions have little track record of success. After decades of sanctions on North Korea, the Kim family remains firmly in charge and can finally boast submarine-launched ballistic missiles on which to pack their nuclear warheads. Saddam Husseins Iraq was under sanctions for years, but it still took an invasion to kick him out. Similarly, Iran has been under sanctions for much of the time since the 1979 revolution, and yet the ayatollahs remain in power.
History tells us that sanctions are more likely to produce resistance than capitulation. Were a foreign government to cause the value of U.S. Social Security checks and Medicare spending to fall by 40 percent, the American public would be enraged, call it an act of war, and demand a military response. Under similar pressures, does Iranian belligerence come as a surprise?
But what can Iran do, when it is so effectively cornered? Tehrans options are effectively limited to raising the cost of the sanctions regime to the United States. Rather than concede a win-lose outcome to Washington, Iran is left with a lose-lose strategy, in effect, risking a war to demonstrate to the United States that the political cost of sanctions on Iran are too high.
This involves inflicting pain on the United States, its allies, and the global economy. But how to do it?
The Iranians need to strike blows without being labeled as the aggressor. A war, particularly a prolonged war in which Iran is seen as the instigator, would be an abject disaster for Tehran. Therefore, acts of aggression must be deniable to the greatest extent, even while signaling that Tehran was behind the move.
Further, should matters escalate to an overt military conflict, the United States or Saudi Arabia must be seen as the aggressor. This limits Irans opportunity to strike the United States or Saudi military assets directly or to undertake operations with substantial civilian, and in particular American, casualties. The Iranians could fire a couple of cruise missiles into a U.S. warship at any time but doing so would enrage the U.S. public and mobilize America for war. Iran wants no part of that.
Rather, with indirect and deniable attacks targeted against Saudi oil facilities and infrastructure, Iran hopes to goad the United States into a response, if not the withdrawal of sanctions, then an attack on Iran proper. In such an event, Iran would appeal to global public opinion, maintaining that it is merely protecting its own vulnerable population from aggressive and unjust treatment by the United States, and that any actions Tehran may take are justified in protecting its legitimate interests. If only Washington had not placed crushing sanctions on Iran, none of this would have happened! That is the line Tehran must play.
But it is a very fine line, and therefore the strategy has been unfolding only gradually. The program opened with the downing of a U.S. drone in early summer, followed by the seizure of various oil tankers, and progressed most recently to an attack on Saudi oil facilities.
And what an attack it was.
It was perfect. Launched in the early hours of Saturday, September 14, the attack relied on drones and cruise missiles to destroy key components of Saudi oil processing facilities at Abqaiq. This reduced the Kingdoms oil production by more than half while killing no civilians or Americans, blurring Iranian involvement, and paralyzing U.S. decisionmakers with respect to a response. The strike exposed the Saudi economy and royal houses as vulnerable to punishment at Tehrans choosing. It was a brilliant plan, flawlessly executed.
The U.S. administration, frightened of precipitating a general war, limited its response to tighter sanctions on the Iranian central bank, tightening the financial noose into something closer to an economic blockade.
Given that Iran has even less to lose now, Tehran has little choice but to escalate. The team who took out the Saudi facility will be back to take another shot.
Indeed, one cannot help but wonder about the fire which engulfed sections of the $7.3 billion Haramain train station in the western city of Jeddah on Monday, Sept. 29. The cause was not immediately determined, but it would certainly fit the Iranian strategy as laid down here. The death sentence given to an alleged U.S. spy on October 1 would constitute yet another ratchet as Tehran looks to turn up the heat on the Trump administration.
Given the constraints on Tehran, the timing and targets of a follow-up strike can be reasonably surmised. If the Iranians intend to focus on Saudi oil operations, then Abqaiq remains the most attractive target, with the leading alternatives the Saudi crude export facilities at Ras Tanura or Ras al-Juaymah on the Persian Gulf, or perhaps a product tanker loading there. Tehran may alternatively try its hand with other Saudi infrastructure, but threats to the Persian Gulf oil trade will make the biggest impression in Washington.
Time is short. If too much time elapses before the next strike, Washington will brush off Tehran as lacking seriousness, as well as allowing Saudi Arabia to better prepare its defenses. Therefore, the next attack should occur within a six-week window, say, from mid-October to early November, with much to argue for a follow-up strike on Abqaiq as the designated target.
Iran might be expected to rinse and repeat this cycle until the Trump administration can no longer look the other way. At the outside, two more strikes should do the trick, a program which Tehran should be able to execute before Christmas.
Should the United States choose to respond with air strikes on Iranian territory, Tehran would have the opportunity to attempt to close the Strait of Hormuz, or at least eliminate Saudi and UAE oil shipments from the Persian Gulf. According to a report from the Director of National Intelligence published this past January, the Iranians can call on a wide range of suitable weapons and tactics to this end:
Iran continues to develop, improve, and field a range of military capabilities that enable it to target U.S. and allied military assets in the region and disrupt traffic through the Strait of Hormuz. These systems include ballistic missiles, unmanned explosive boats, naval mines, submarines and advanced torpedoes, armed and attack UAVs, anti-ship and land-attack cruise missiles, anti-ship ballistic missiles, and air defenses.
We believe these systems can materially impede the flow of oil through the Persian Gulf for an extended period of time. Iran does not have to sink every ship, merely make the risk-reward trade-off unappealing for tanker owners. They will avoid the Gulf altogether if missiles start to fly.
The Strait of Hormuz is critical to the global economy. Twenty million barrels of oil20 percent of the worlds oil supplytraverse the narrows every day. Saudi and UAE exports alone provide 10 percent of world oil consumption. Historically, major oil shocks have seen the global supply fall by 6 percent to 8 percent for a relatively short time, typically a few months. This has proved plenty to cause a global recession, usually within ninety days, and often within thirty.
The oil price shock of 2008 preceding the Great Recession, and again in 2011 with the Arab Spring, demonstrate that oil crises can still bring down the global economy, even if at a higher price than in, say, 1973. Indeed, University of California San Diego economist James Hamilton notes that all but one of the 11 postwar recessions were associated with an increase in the price of oil, the single exception being the recession of 1960. Almost all of these eventsbar the oil price shock of 2008were associated with supply outages resulting from Middle East conflicts involving the Gulf countries. An oil shock resulting from a Persian Gulf War would not be the exception to the rule, but rather the most common
trigger for a worldwide recession. The closure of the Strait of Hormuz for even a month or two would be sufficient to put the global economy into a deep downturn similar to the oil shock resulting from the 1979 Iran-Iraq war.
Nor can the Gulfs oil be replaced by other sources. U.S. shales certainly provide a buffer, but our analysis suggests that shale production will peak in early 2020 if rig counts continue to decline as they have for almost a year. U.S. shales can be restarted with higher oil prices but adding just one mbpd would require six to eight months. The United States could not, even at a two-year horizon, displace a loss of more than two to three mbpd, regardless of the oil price. A loss of twenty mbpd would exceed anything U.S. shales could cover by an order of magnitude.
Nor is there space capacity outside the US. Since 2005, the United States by itself is responsible for almost three-quarters of the increase in the global oil supply. OPEC supply has hardly budged, and such reserves as exist are concentrated in Saudi Arabia and the Gulf countries, exactly those impacted by a closure of the Strait of Hormuz.
To an extent, production losses could be buffered by strategic reserves positioned around the world. Key countries maintain strategic stockpiles of perhaps two billion barrels of crude. This may sound impressive, but it represents only a three month cushion at twenty mbpd. Moreover, oil prices would rise sharply far before the reserves approach exhaustion. Strategic reserves are unlikely to prevent market panic for more than a month or two at the most.
And the Iranians know that. Tehran, therefore, intends to put the Trump administration into an impossible bind, having to either passively countenance repeated strikes against Saudi facilities, escalate the conflict into an explicit war likely resulting in a global economic meltdown, or relenting and allowing the Iranians to export sufficient oil to fund essential government services.
Were Washington ruled by the simple logic of the matter, then a deal should be struck here. The Iranians are under tremendous pressure: the Abqaiq strike tells us that. An unprovoked strike on a nations critical infrastructure is a cause for war. That Tehran would risk it is a measure of its desperation.
Moreover, the choice of target is also illuminating. Iran could have struck military targets, or major civilian centers and inflicted major causalities. Rather, it only struck a processing plant, and at the time of the week when the facilitys staffing levels would be lowest and farthest from the processing lines. This tells us that Iran does not want war. Tehran is looking to inflict pain, but without the bitterness of death.
Further, the Abqaiq strike was not prepared by angry, irrational people, but by a professional, interdisciplinary team who carefully weighed their risk-return payoffs. They will appreciate that Iran is far better served by accepting some of the Trump administrations twelve points demands than escalating the conflict.
These three factors tell us that Iran is ready to make a deal, and quickly.
Nevertheless, the strikes also tell us that Tehran is not willing to simply roll over and give up. If they are backed into a cornerand they are nowthey are willing to resist. Iranian pride prefers to go down fighting than live cowering in the dark.
Within those constraints, however, a deal looks readily available.
How can the Trump administration respond? It cannot readily reward Tehran for smashing Saudi oil infrastructure. Indeed, Secretary of State Pompeo on September 25 laid down the official line: The more Iran lashes out the greater our pressure will and should be.
Therefore, events would seem to grind inexorably towards a military conflict between Iran and the United States.
Where events take us past this point is hard to say. The United States is unlikely to launch a land invasion of Iran; consequently, efforts would be limited to the use of air power. On the other hand, air power alone will not prevent Iran from taking potshots at slow-moving and easy-to-hit oil tankers. It is likely to be a mess; that much is for sure.
That is, of course, not the only possible outcome. To date, Trump can claim success in pressuring Iran. He has impressive cards to play and the numbers say he can quickly convert a deal far better than President Barack Obamas. Will the White House seize the opportunity? Probably notbut the president may still have sixty days until the point of no return.
Steven R. Kopits is the president of Princeton Energy Advisors. He writes about oil markets and related geopolitics.
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