FROM THE ECONOMIST INTELLIGENCE UNIT
The muted reaction of the oil market to Iran's warning that it would close the Strait of Hormuz if the West imposed restrictions on Iran's ability to export oil reflects the consensus view that the threat is largely bluff. However, the risk of a military escalation over the right of passage of oil and gas tankers through this vital waterway cannot be dismissed out of hand, particularly if the US and the EU go through with their threat to target Iranian oil exports in new sanctions.
The Iranian warning came in the form of a comment on the official Islamic Republic News Agency on December 27th by the first vice-president, Mohammed Reza Rahimi, who said that if the West extended sanctions to Iranian oil exports "not one drop of oil will pass through the Strait of Hormuz". The threat was amplified by naval manoeuvres and by a comment by an Iranian admiral that closing the waterway would be easy to accomplish.
The Iranian statements follow indications that the US administration is considering ways to impose a worldwide ban on dealings with the Central Bank of Iran, which would create severe problems for the processing of payments by importers of Iranian oil, and come as the EU is contemplating imposing a ban on member states buying any oil from Iran. The oil price edged up briefly on the news, but the gain was not sustained, as the current price already incorporates a risk premium related to the dispute over Iran's nuclear programme and the market is also being pulled down by the increasingly weak global demand outlook. Officials from the US State Department and Department of Defense emphasised that the US would not hesitate to use its considerable military forces deployed in the region to break any such Iranian blockade.
Sparring
The verbal exchanges and the respective military moves by Iran and the US in the area amount to low-level sparring rather than a serious squaring up. A comment from an Iranian vice-president clearly carries less force than a policy statement from the president, Mahmoud Ahmadinejad (who has hardly been seen in public for several weeks), or the Supreme Leader, Ayatollah Ali Khamenei. The US president, Barack Obama, has also refrained from getting involved at this stage.
Energy chokepoint
However, mere mention of a possible conflict over the Strait of Hormuz provides a stark reminder of how high the stakes are. More than one-third of the world's tanker-borne crude oil passes through the waterway, along with about 25% of global liquefied natural gas (LNG) supplies and a significant quantity of products such as liquefied petroleum gas (LPG). The message from Iran is that it would not be prepared to sit back and watch Saudi Arabia, Abu Dhabi, Qatar, Kuwait, Iraq and Bahrain export their oil and gas by tanker through the strait while it was unable to dispatch its own cargoes. Under such circumstances Iran would face economic ruin, while its Arab neighbours would garner windfall profits from higher oil prices and, most likely, increased volumes of oil sales. In the event of the strait being closed, Abu Dhabi could get about 1m b/d out to market through a newly opened pipeline to Fujairah, on the Arabian Sea, and Saudi Arabia could export limited quantities from the Red Sea through reconfiguring its internal pipeline system. The poor state of Iraq's domestic pipelines means that most of its production in the south would be locked in. Kuwait, Qatar and Bahrain would be unable to export any oil or gas.
Lose-lose scenario
Asian oil and gas importers would be most severely affected, in particular China, which in November imported 1.2m b/d from Saudi Arabia and 600,000 b/d from Iran, these two countries alone accounting for one-third of its total oil imports of 5.6m b/d. The US and the EU are less heavily reliant on crude supplies from the Persian Gulf, but their economies would still be severely affected by the inevitable spike in oil prices. The US military has been preparing for such an eventuality for at least 30 years, and it is unlikely that Iran would be able to keep the strait closed for more than a few weeks (or even days). The US would undoubtedly take advantage of the situation to try to inflict as much damage as possible to Iran's entire military infrastructure. However, Iran will also have prepared contingencies to wage asymmetric warfare to ensure that the costs to the global economy and to its Arab neighbours are maximised.
Masochism tango
Given the strong probability that all of the protagonists would suffer grievous harm from an escalation of conflict over the strait, not to mention the damage that would be inflicted on an already wobbly world economy, the question arises as to why the US and the EU are intent on stirring the pot. The much-trumpeted International Atomic Energy Agency (IAEA) report that came out in October did not add anything substantial to what was already known or suspected about Iran's nuclear activities. Its conclusions were in fact remarkably similar to those of the 2007 US National Intelligence Estimate, which was criticised at the time for being too soft on Iran. Citing sources in several intelligence agencies, the IAEA stated for the first time that it was convinced that Iran had conducted activities prior to 2003 that indicated that it intended to develop nuclear weapons. At the same time, the IAEA acknowledged that it did not have any evidence of a military dimension to Iran's ongoing nuclear fuel programme. Among the possible explanations for the Western powers' actions is that they fear that time is running out, as Iran is getting close to the point at which it will be able to draw together all the various elements of its uranium enrichment activities and its missile technology development to turn itself into a nuclear-armed power. There may also be a calculation that increasing the economic pressure on Iran will influence domestic politics and enable a shift in the internal balance of power in favour of interest groups that are ready to negotiate in good faith about an agreement guaranteeing that Iran would not be able to produce nuclear weapons.
However, the supposition that the US and the EU are proceeding on the basis of a well thought-out plan is at odds with the reality of a hesitant and reactive US presidency and an EU that is in existential crisis over the euro. That raises the suspicion that there is a growing risk of the West blundering into a catastrophic confrontation with Iran. Given the major interests that it has in the region, China is likely to be watching these developments with increasing anxiety.