Politics in the Middle East are to geopolitics what the Bolshoi Theatre is to ballet. Over the last two years, Israel has proceeded to chop away at Iran’s assets, until last Friday, it launched a James Bond-style strike at Iran proper that caught the Islamic Republic completely unaware.
Iran has relied on proxies in its decades-long conflict with Israel. On Israel’s southern flank Hamas operated in the Gaza strip. To the north of Israel Hezbollah occupied southern Lebanon. Bashar al-Assad’s Syria allowed Iran to supply Hezbollah whilst threatening Israel. Israel has dismantled both Hamas and Hezbollah and Bashar al-Assad is in exile in Russia, which allows Israeli warplanes to encumbered to Iran. Due to its emphasis on proxies, Iran has underinvested in air defence, which now allows Israel to fly in Iranian air space cost effectively dropping bombs whilst Iran has to rely on expensive ballistic missiles.
The Game
Israel maintains that Iran is close to building nuclear weapons and believes the Iranian regime is ripe for toppling. Israel’s prime minister, Benjamin Netanyahu, has lobbied U.S. president Donald Trump to seize the opportunity and deliver a killing blow to the Iranian regime. Israel hopes that the U.S. joins the fight, and regardless, will continue to attack Iran for as long as possible. Israel is effectively attacking military and economic targets with the exception of Iranian energy infrastructure geared for exports, because the U.S. does not want higher energy prices.
Iran is on the ropes. Israel has managed to eliminate a substantial number of the top Iranian military leaders and has hobbled air defences. Iran is trying to do as much damage as possible to Israel whilst being careful not to attack U.S. assets or Arab energy assets, because it does not want the U.S. to join the Israeli war campaign. Hence, aggravating the U.S. is a constraint faced by both parties.
Figure 1: Oil prices rose after Israel attacked Iran, but prices are still below January levels
Dire straits
From an economic and market perspective, the significance of the Middle East is of course oil and natural gas. Twenty percent of which flows through the Strait of Hormuz. Iran threatened to blockade Hormuz throughout the 1980-1988 Iraq-Iran war and multiple times since. It hasn’t and likely won’t for two reasons.
The first reason is that Iran has been hurt by sanctions and poor economic policies, which means that its exports of 1.5-2 million barrels of oil a day are a lifeline. Hence, the closing of the straits would have dire implications for Iran’s economy.
The second reason is fear of U.S. intervention in the war. Iran toyed with closing the straits during the Iraq-Iran war in the 1980s and the U.S. responded through a devastating bombardment of the Iranian fleet and infrastructure. Since then, Iran has not closed Hormuz. Now, with its proxies eliminated, Iran is even more reluctant to anger the U.S. especially with a relatively unpredictable U.S. president.
Black gold loses its shine
The U.S., Europe, and Japan were increasingly dependent on oil since the Second World War. The 1973 Arab oil embargo and the 1979 Iranian Revolution caused oil prices to spike and triggered recessions across Western economies, as well as sparking high inflation. These crises led to a drive for fuel efficiency and energy diversification, including nuclear, coal, and renewables.
The shale oil revolution drastically changed the global economy’s dependence on OPEC oil. The U.S. became the world's largest oil producer, reducing its reliance on imports. Shale oil has changed the dynamics of the oil market in a fundamental way. Traditional oil sources, such as offshore oil, are very expensive to ramp up or shut down. Hence their production is nonresponsive to price swings. North Sea oil rides out price declines. Shale oil fields are inexpensive to ramp up or shut down and they can be short-lived. Hence, shale oil is reactive to oil price swings in a way traditional oil is not, which may help stabilize the oil market.
Figure 2: U.S. oil production surpassed Saudi Arabia’s oil production in 2018
The Middle East is important because oil is important and will remain so. However, OPEC’s actions in the 1970s marked the countdown to the fall of oil’s pre-eminence, a trend which shale oil has reinforced. The rise of electric transport and renewables will further entrench this trend.
