New Middle East Proxy War Could Jolt Oil Prices

U.S. president Trump still boasts that Iranian exports will be falling to zero, but some tankers are still going to slip through the cracks. ‘Illegal’ crude oil trade will be almost negligible, however, as Iran’s main customers have realized that Washington’s wrath will be real. The mullah regime in Iran also put its trust in a possible European answer, but European companies have chosen to be very cautious, and not to rely on the EU to mitigate potential U.S. sanctions against their operations. The more robust line taken by Washington, supported by Arab allies, seems to be working, as long as analysts are keeping an eye on Iranian oil sector options.

Oil analysts are also not yet worried by the negative impact of the sanctions as the global markets are still reasonably well supplied. This picture, however, could be changing extremely quick, if several underestimated factors begin to play out.

In contrast to the overall reporting, in which a direct Iran-U.S. confrontation seems to be in the making, reality shows that a surprising risk lies in Iraq. Analysts are focusing on the Arab/Persian Gulf, due to the announcement made by Washington that a significant U.S. naval force is steaming up to the region, partly to project U.S. military power and to counter a possible Iranian move to block the Strait of Hormuz. But the real conflict could play out in Iraq.

Washington admitted that it has been warned of possible attacks by Iraqi militias or IRGC proxy groups in Iraq on U.S. forces. The latter, as indicated by Tehran officials, would not only be in Iraq but potentially in the whole region. This proxy-war approach by Tehran has been expected for a long time, as Iran understands that a full-blown military confrontation with the U.S., and potentially its Arab allies, would not end well for the mullahs. Even if the conflict would be costly for both sides, the outcome is clear.

This strategy, as already has been employed by Iran’s IRGC troops in Syria, Lebanon, Yemen and parts of Iraq, would however be much harder to quell. Not only would the U.S. be forced to spread its forces, but low-level intensive military operations in mainly civilian areas would also constrain a U.S. response. It would also be very hard for Washington to compel European allies and the international community to form a united front against Iran.

Several analysts have already suggested that the first possible battleground of this looming conflict will be in Iraq. U.S. Central Command spokesman Urban reiterated previously that “the USCC has seen preparations by Iran and its proxies to attack U.S. forces in the region”.  U.S. forces based in Iraq are the easiest to attack. Iraqi Shi’a militias are spread over the whole country, and more often than not are operating under the flag of the Iraqi government.

Taking into account the presence of hardline fundamentalist groups in the area, Tehran can mount a strong force without officially taking part in attacks against the U.S. The same could be done in Syria or Yemen, targeting U.S forces and its allies in the area. By using Hezbollah or Hamas, Tehran would even be able to instigate a full-scale regional war, forcing Israel to take part in the conflict.

Proxy wars in several countries in the Middle East could have a detrimental effect on global oil and gas markets. Any disruption to oil and gas flows cannot be countered by increased OPEC output or even U.S. shale oil. The market may seem well supplied, and inventories are still at relatively high levels, but this reality could soon change.

Until now, the market is behaving like an ostrich. By putting its head under the surface, and convincing itself that there is enough crude supply, or that ‘turning on the taps could rapidly add the missing barrels. The looming war in the Persian Gulf is only assessed on the merits of a US military invasion of Iran, which is unlikely to happen.

If the Iranian regime realizes it is heading for the brink, its proxies will do its bidding. On the global oil market, volumes are no longer the only factor of importance. It is quality and crude grades. These two factors are not being recognized, and it seems that traders and analysts believe Trump’s version of reality at present. OPEC’s spare production capacity is not sufficient, as Iran and Venezuelan heavy crudes are in short supply.

The U.S. is not able to substitute any of this in the short-to-mid-term. When the market hits the brick wall at the end of this year, this quality problem, in combination with increased instability in the Middle East, will not only create a nightmare scenario for consumers but could also push crude oil above the current $70-85 per barrel range. Proxy wars and sanctions could create the perfect storm for oil. A possible spike to $90 seems within reach.

By Verocy for Oilprice.com