Iran: misunderstandings and miscalculations

Summary: Trump has reneged on the Iran nuclear deal. Aim to cut Iran down to size but without a strategy to achieve it. Other parties to the deal unlikely to play his game. Tehran’s position likely to harden, sharper confrontation with Israel, impact on world oil.

Once again we are grateful to Alastair Newton for the article below, which will shortly be published on the Global Lead website.  Alastair worked as a professional political analyst in the City of London from 2005 to 2015. Before that he spent 20 years as a career diplomat with the British Diplomatic Service.

“Iran will never again have carte blanche to dominate the Middle East.”

(US Secretary of State Michael Pompeo, 21 May 2018)

When US President Donald Trump walked away from the Joint Comprehensive Plan of Action (JCPOA) on 8 May, his overall ambition was reasonably clear. But the consensus — among not only the commentariat but also the other parties to the agreement — was that, at that stage, Washington had no ‘Plan B’ setting out how he proposed realising his goals. However, to an extent at least, this gap has since been filled by Secretary of State Michael Pompeo’s 21 May speech to the Heritage Foundation.

Coupled with the threat of “the strongest sanctions in history”, Mr Pompeo laid out 12 conditions by which Iran had to abide if it is to be granted a new deal on sanctions relief, including:

  • Abandoning totally and in perpetuity uranium enrichment;
  • Scrapping its ballistic missile programme;
  • Withdrawing all support for its allies in the region, notably Hamas and Hizbollah;
  • Withdrawing its forces from Syria and (to the extent they are present there) Yemen;
  • Stopping meddling in Iraq; and,
  • Ending all “threatening behaviour” towards other countries in the region.

Mr Pompeo made it clear that he expects full backing for his plan not only from America’s European allies but also from “Australia, Bahrain, Egypt, India, Japan, Jordan, Kuwait, Oman, Qatar, Saudi Arabia, South Korea [and] the UAE”.  But it is far from sure that this will be forthcoming. As has been well documented in the press, the three European signatories to the JCPOA — France, Germany and the United Kingdom  — intend standing by their obligations under that agreement (difficult, if not near impossible, though it will be to protect their businesses from secondary US sanctions). India is very unlikely to toe the Washington line given its growing economic ties with Iran. Kuwait, Oman and, perhaps especially, Qatar will not be enthusiastic. And even Japan — whose Prime Minister, Shinzo Abe, has been ill-rewarded on both the trade front and North Korea for his efforts courting Mr Trump — may balk.

As for the other JCPOA signatories, Russia has already openly condemned the US’s move and President Vladimir Putin has shown some willingness to work with French President Emmanuel Macron to try to preserve the deal. China, on the other hand, has been conspicuous in its relative silence; but we may safely assume that Beijing will be looking for opportunities to deepen its economic engagement with and geopolitical influence in Iran, which is a key partner in President Xi Jinping’s ambitious Belt & Road Initiative (BRI) .

In other words, despite Mr Pompeo’s seeming willingness to try to force compliance from third countries (including US allies) through secondary sanctions, it seems very unlikely that the US will manage to conjure up the sort of united front internationally which was instrumental — indeed, essential — in brokering the JCPOA in 2015.

There may be some in Washington who genuinely believe nevertheless that the tough sanctions regime which Mr Pompeo has promised can be imposed on Iran; and that, as a result, Tehran will come to the table and capitulate. But it is unlikely that their number includes either Mr Pompeo or National Security Advisor John Bolton, both of whom are experienced and thoughtful operators. Indeed, we can be pretty confident that both realise that, far from weakening the regime’s resolve, the US’s current approach will strengthen the hardliners in Iran.

However, it is still likely that serious misunderstandings prevail in current thinking in Washington. Most notably, there does seem to be a belief there — quite possibly shared by Messrs Pompeo and Bolton — that the US’s tough stance will somehow induce regime change in Tehran. But this certainly does not appear to be a view which is widely shared among Iran experts outside Washington. For example, David Gardner in the 22 May edition of the Financial Times (subscriber access only) put it as follows.

“What the Trumpian pyromaniacs have actually done is to re-legitimise hardliners in Iran grouped around the Revolutionary Guard Corps, the judiciary and the theocratic leadership. The 2015 accord re-energised the drive for change inside Iran. It gave Hassan Rouhani, architect of the accord, a second term as president. The guards and their supporters are now exulting after Mr Trump came to their rescue by scuppering it. The pragmatist camp led by Mr Rouhani has been politically crippled. How can they still argue Iran should continue to honour an international deal the US just ripped up?

Ayatollah Ali Khamenei inspects his troops

The slim but real chance of a more open society in Iran under looser theocratic tutelage — there had been proposals for a leadership council to replace the Supreme Leader, 78-year-old Ali Khamenei, once he leaves the stage — has ended. Iranians dreaming of rejoining the world are instead faced with what Mr Pompeo said ‘may end up being the strongest sanctions in history’. Ranks are closing across Iran’s diverse spectrum. Bolton-esque regime change is a fantasy.”

 Mr Gardner goes on to note that, even though expert opinion is skewed towards the US failing to achieve its objectives under its new approach, a direct military strike on Iran per se by either the US or Israel (let alone Saudi Arabia) remains unlikely in the foreseeable future. But this does not rule out, by any means, a further escalation of the ongoing proxy wars in the region. Indeed, it may be both a taste of things to come and no coincidence that Iran’s first ever attack on Israeli-held territory came just hours after Mr Trump had effectively withdrawn the US from the JCPOA.

Thus, the biggest immediate related risk appears to lie not with Iran and the US but in Iran/Israel relations. The aforementioned missile attack this month by Iranian (or, possibly, Iran-backed) forces based in Syria on the Israeli-occupied Golan Heights already amounts to a significant escalation. Israel’s retaliatory airstrikes (which appear to be ongoing  may serve to slow down the Iranian build-up in Syria; but Tehran is not only very unlikely to back off but will also very likely look to retaliate against Israel in some way, possibly by terrorist attacks on Israeli (or US) assets or citizens in third countries. Such a step would not go unpunished; and, although it seems unlikely that either party wants an all-out war, we appear to be sliding dangerously towards the point where this could occur through miscalculation, if not deliberation.

Oil: On the one hand…

 “Looks like OPEC is at it again. Oil prices are artificially Very High! No good and will not be accepted!”

(Donald Trump on Twitter, 19 April 2018)

Clashes between Iran and Israel in the Golan area do not, of course, pose any direct threat to oil output (which may not, of course, prevent further knee-jerk price rises if and when there are more confrontations). But the oil market does currently have to cope with at least two other essentially political risks. First, we saw Venezuela’s output fall almost 20% last year, attributed largely to a combination of incompetent management and the country’s dire domestic political situation; given the ever-increasing political precariousness there who is to say that there isn’t more to follow? Second, at the start of April the Houthi rebels in Yemen twice launched missile attacks on Saudi Arabian oil-related assets in that period. As David Sheppard highlighted in the 5 April edition of the FT (subscriber access only):

“Oil traders, distracted for now by a brewing trade war between the US and China, are at risk of growing complacent. But it is unlikely they will be able to discount Saudi Arabia’s conflict in Yemen much longer.”

 Coupled with Mr Trump’s withdrawal from the JCPOA, Brent hovering around USD80p as it was in mid-May (ie up around USD14pb since the start of the year and USD5pb in the wake of the 8 May announcement) hardly seems unreasonable.

 However, it is not clear as yet that US actions will cut Iran’s exports, currently around 2.6mbpd; or, if so, by how much. Some experts have speculated that we may lose around 200,000bpd from international markets; on the other hand, Tehran is putting the EU under considerable pressure to protect its oil exports if the Europeans wish to preserve the JCPOA.

Furthermore — and almost certainly accounting largely for Brent’s slide back below USD76.50 at the end of last week — it is possible that Saudi Arabia and Russia may agree to boost output (as Mr Trump has demanded) by as much as 1mbpd, nominally to offset any lost exports from Iran (but, to a large extent, compensating for over-compliance with Opec-agreed cuts, in fact). If they do, Opec would then likely endorse any such agreement when it next meets on 22-23 June, although sorting out new quotas could prove tricky given the small number of members with the capacity to increase output.

An additional downside risk to the current price lies in Mr Trump’s trade agenda. During the week of the two Houthis missile attacks on Saudi oil-related assets, Brent actually sold off by around 3% over concerns that China and the US were about to slide into a trade war. This risk clearly still exists even though it is currently hard to determine whether it is rising or falling.

In short, oil producers and consumers alike are faced with upside and downside risks to the current oil price and the likelihood that the relative strength of those risks will continue to fluctuate, driving more volatility into the oil market. Nevertheless, given the high probability of tensions in the Middle East continuing to rise and repeated reports of Riyadh’s desire  to sustain a price of at least USD80pb (not least with an eye to the proposed listing of Saudi Aramco), on balance we may still be more likely to see Brent around USD80pb than USD70 through the second half of the year.

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