War Consequences
We are getting questions about the consequences of the fighting between Iran and Israel. The potential certainly exists for massive change politically in the Middle East, but the economic consequences are likely to be far more muted.
Israel has quickly gained control of the skies over Iran and it is clearly focused on military and leadership targets, with highly selective targeting of Iran’s energy assets. Iran exports roughly 90% of its oil from Kharg Island, which is a highly vulnerable facility within easy reach of Israeli jets. Israel clearly has other priorities. It continues to hit Iran’s nuclear sites, missiles facilities, military and political leadership, and other strategic targets. It just hit the state broadcaster.
The decision to avoid hitting oil facilities is also strategic. Regime change is without any doubt a major objective. The Israelis can’t do that on their own, but clearly hope that the Iranian public rises up against the regime. John Bolton also presents that as an important objective in an editorial in today’s WSJ. The Iranian public is largely opposed to the existing religious leadership and pro-West, hates their government, and has been suppressed violently whenever it has voiced its displeasure. Should a democratic government come about, it would radically change the politics of the entire Middle East. Hezbollah, Hamas and the Houthis in Yemen would lose their sponsor and military supplier. The Saudis and Emirates would breathe easier with the disappearance of the Mullahs. Russia would lose a major source of drones. There is little doubt the world would become a safer place.
Not attacking oil facilities avoids crippling Iran and its ability to rebuild once a ceasefire is negotiated. If a democratic government comes to power, they will need to be able to sell oil to rebuild. If the mullahs remain in power, Kharg Island might be toast. But that decision doesn’t need to be made yet. And because Iran, Qatar and China would be adversely affected far more than Western countries, it is unlikely that Iran would close the Strait of Hormuz to shipping. This implies that Iran’s oil shipments may continue. Indeed, there are several reports that Iran is actively seeking a de-escalation of the fighting. It is hard to imagine this occurring without Iran agreeing to shut down its uranium enrichment and terminating its nuclear bomb efforts. Since such actions don’t appear acceptable to Iran, as yet, the fighting is likely to continue.
Investors are recognizing some of these points already, so oil prices are down sharply today after running up very sharply last week. The market is judging that oil supplies may not be curtailed despite the heavy fighting. We agree. Israel has more strategic targets to attack. This war may linger for some time, surely days, maybe weeks. But if Iran’s ability to export oil is not destroyed, which Israel has chosen to avoid for now, the broader economic consequences are likely to be second or even third order. So, U.S. stocks are rallying today after last week’s knee-jerk reaction to the downside.
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