Heisenberg Report

Why One Bank Thinks Iran’s Next Move ‘May Not Involve Oil At All’

In remarks to reporters on Tuesday, Mike Pompeo accused Tehran of undermining the peace process in Afghanistan and generally parroted the party line in defense of Donald Trump’s momentous decision to carry out an extraterritorial assassination of Iran’s second-most powerful person.

“Soleimani was not on a diplomatic mission to Iraq when he was [killed]”, Pompeo remarked. He also promised that every target in Iran the US might theoretically bomb would be “within international law”. Trump continues to undermine that messaging with threats to target cultural sites.

As far as Iran’s response is concerned, there are good arguments for the contention that, the country’s bombastic rhetoric aside, retaliation for Soleimani’s death may not take the form of a dramatic, “go big or go home” strike.

For one thing, if what Tehran seeks to do is drive up the price of oil, perhaps to the detriment of Trump’s poll numbers in an election year, it might be better to hew closer to the existing strategy, which generally involves targeted, smaller-scale attacks.

“If there were a single high-impact act of Iranian retaliation, this could in fact most quickly deflate the [risk] premium” in oil, Deutsche Bank’s Michael Hsueh writes, in a note dated Monday, before noting that “the likelihood of a more-protracted campaign of opportunistic strikes, and the low likelihood of de-escalation, may extend the longevity of the risk premium”.

Remember, the spectacular attacks on Abqaiq and Khurais in September succeeded in driving up the price of oil sharply, but things quickly calmed down. The steady climb into year-end had virtually nothing to do with geopolitical risk, and everything to do with the reflation narrative gaining traction.

If the idea is to punish the US (with minimum collateral damage for everyone else), the best strategy might not even be one that focuses on engineering an oil supply disruption.

“If Iran’s primary target is the US, then the US is already less import-dependent than it has been in many years”, Deutsche’s Hsueh goes on to say, noting that “the US timed its attack well from an oil-data standpoint [as] in the week ending 27 Dec, the US’s combined trade in oil and oil products showed the largest net export on record of 1.7 mmb/d”.

(Deutsche Bank)

China’s dependence on Persian Gulf oil supply is comparatively large (versus the US anyway), and just about the last thing Iran wants to do right now is alienate the Chinese, who cautioned against any further unilateral military action from the US this week.

Hsueh underscores the necessity of preserving the relationship with Beijing, describing it as “one of the few which Iran can still rely upon for outside support, not to mention the possibility of China as a destination for much-needed foreign-currency revenue through covert oil or oil-product sales”.

Given that, Iran may want to avoid taking any kind of action that could meaningfully disrupt oil production.

When it comes to the prospect of another incident like that which occurred in September, another obvious consideration is that it will be more difficult to pull off given the deployment of air defense systems and the proximity of US personnel to Aramco’s infrastructure, although that latter point kind of begs the question if the whole idea is to inflict casualties upon Americans.

As far as the Strait, there are similar considerations at play. Thanks to last summer’s dramatics, it will likely be more difficult for Iran to disrupt safe passage without being confronted quickly by superior naval force, and, again, attempting to close the Strait would affect everyone, not just the US. Here’s Hsueh again:

So these two avenues are blunt weapons –they would affect many countries besides the US, not least Iran itself, which still depends on shipping for trade in basic goods and medicines. A halt to all seaborne trade through the Strait may incrementally worsen living conditions and risk reigniting popular unrest in Iran, which has recently been stirred by the elimination of monthly cash subsidies in early November and the reduction in gasoline subsidies in late November.

Deutsche Bank now characterizes their bearish call on oil in H1 2020 (based on oversupply concerns), as “postponed but not canceled”. “Even subtracting the USD 5/bbl increase in risk premium since Friday, Brent at USD 65/bbl implies the assumption of an undersupplied market”,  Hsueh says.

They do, however, see oil vol. higher in the near-term.

Of course, if Iran’s next move “doesn’t involve oil at all”, as Deutsche suggests, that would entail retaliatory measures that, while perhaps not as grandiose, could be potentially more damaging (e.g., cyberattacks) and/or more deadly (e.g., attacks on US bases and personnel).

Read more: Forget The Trade War, Mideast Shooting War Grabs The Wheel For Oil Prices