Hormuz and Oil: The Global Problem of a Global Market

Council on Foreign Relations (CFR)

Newswise — Oil is a global commodity where prices adjust to a supply disruption in one place across all locations, no matter country or location where the problem started. To help people understand what that means, I like to use the analogy of a swimming pool. If one takes a giant bucket of water out of the deep end of a swimming pool, it affects the water level for the entire pool, not just the deep end. The larger the bucket, the more swimmers will notice changes in the water level throughout the entire pool.

The upshot of this global nature to oil is that freedom of movement of oil through the Strait of Hormuz is a global problem. Countries might think that maintaining “good” relations with Iran might mean their ships won’t get attacked, but it is not truly relevant. If anyone’s ships are attacked, the oil disruption that could ensue will affect all oil importing countries.

The International Energy Agency (IEA) was formed out of an understanding of this notion of the global nature of the oil market. Emergency stock releases need to be coordinated because if one country releases strategic stocks and other countries hoard oil instead, the net supply gain to markets can be cancelled out, hence coordinated stock release policy is advantageous. IEA announced this week that it is prepared to act if oil flows are disrupted from the Middle East.

Iran may feel it is getting an upper hand by showing it has been wronged and is a nation to be reckoned with. The problem is Tehran is also showing the world what a problem it could become if it actually had nuclear weapons capability. This week, governments from the U.K. to Germany and to Japan will have to decide how much force to apply to protect oil shipments in their vessels and flag ships. But what if Iran were a nuclear power? The calculus would be quite different. The bargaining process for conflicts where parties have access to missiles with nuclear warheads is altered. Nuclear weapons add additional risk on the party that desires to change the status quo. One can expect the cost is higher for third parties who would want to intervene in regional conflicts. A future nuclear-armed Iranian declaration that only the oil Tehran dictates will be allowed to transit the Strait of Hormuz would present an even more complex situation than today’s geopolitical challenge of sanctions and shipping. The military problem of protecting shipping would become more dangerous and potentially require a military campaign to destroy any active Iranian nuclear warheads before engaging conventional Iranian forces that are blocking free transit of the Strait.

The history of nuclear deterrence theory suggests Iran would never use a nuclear weapon, even if it had one because of the extreme consequence of enormous loss from a second strike. But the possibility of internal political instability can in itself alter a bargaining process.

One might have imagined Iran would not have taken such a decisive act against British vessels for fear of attack by the North American Treaty Organization alliance. NATO did, after all, intervene in Libya in 2011 under a situation perhaps less clear than blockage of an international waterway. 

That leads me to question whether Iran may have overplayed its hand. Now that the strategic risk of a nuclear-Iran is so much more transparent, would Europe still feel it can afford to provide nuclear technical assistance to Iran including equipment under the terms of the 2015 Joint Comprehensive Plan of Action (JCPOA)? China must also see the detriment to itself of a nuclear-armed Iran. It’s easy to facilely link the escalation of tensions with Iran on the Trump administration’s “maximum pressure” campaign, which has disturbed an already tense status quo but now thoughtful analysis needs to be made regarding what the current situation has taught about the war-ready nature of factions within the Iranian government. Some lessons are relevant to future diplomatic solution-building regardless of how we got here. The reality is that conflicts involving Iran throughout the Mideast proceeded – and in some cases escalated- even after the JPCOA took hold. The opportunity that signing the nuclear deal would moderate Iran’s foreign policy regarding regional conflicts and assassination plots in Europe was unrealized, even before the Trump administration reversed the U.S. commitment to the JCPOA.

As Europe moves forward in trying to fashion a solution, Iran (and Russia) will need to consider the changing nature of the global oil business. Iran has to concern itself with the future geopolitics of stranded oil assets. Removing itself now from oil and gas commodity markets and direct foreign investment opportunities at this pivotal time in oil’s potentially declining future might have long lasting negative consequences for its energy industry. Moreover, any military exchange that raises oil prices sharply could become the impetus that the West and China needs to accelerate the shift to low carbon energy more decisively. Such a result would reverberate in Moscow whose natural gas giant Gazprom is already struggling against a rise in renewable energy in Europe. China, which has never participated in a large global oil supply cutoff as a giant oil importer (it was self-sufficient in energy in 1973, 1979, and 1990), may also need to educate itself about the consequences of having one fifth of its oil supply have to traverse the Strait of Hormuz. China has more to lose from a poor outcome between the West and Iran than the West does given its lesser dependence on Middle East oil.

Tehran may decide that its resistance economy is good enough for regime survival and choose the path of continued confrontation. That would be a tragedy for the entire region and present a serious challenge for the United States. The makeshift response to allow Britain to protect its own shipping calls into question whether the U.S. could abdicate (either on purpose or by accident) its vital superpower naval role which regulates sea lanes and, in effect, facilitates global trade. The consequences of the U.S. withdrawing from such a role is unthinkable for all concerned, even for the Chinese, who may seem to object to U.S. ships in the South China Sea, but, in reality, free ride off of U.S. air and naval power in so many aspects of their economic life. China should be careful what it wishes for. The Trump administration must avoid reconsidering this critical naval role nonchalantly. It is central to the United States’ global authority.  Just the appearance of U.S. hesitation about that role could invite unwanted seafaring military incursions and piracy across the globe.

If Iran decides that conflict is better to regime survival than concession, the Trump administration’s lack of a well thought-through, implementable strategy regarding Iran will become an even larger problem. Oil markets will increasingly lose their imperviousness to risk as more speculators bid oil prices up. Regional allies could also become more insecure. All this means that now would be a good time to move away from ideological bents and study up on years of U.S. military gaming exercises regarding the Strait of Hormuz. The U.S. military has years of study and knowledge to fashion and lead an effective international coalition for diplomacy and deterrence in the Strait of Hormuz. It should use it.

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