Oil prices are up more than 30 per cent from six months ago amid fears that Israel or the United States may strike Iran.
Concerns have spread that military conflict would cause a major shock to oil prices, damaging global economies. While the situation is serious, such predictions are unlikely to pan out. Understanding how such fears are exaggerated would clarify the stakes in the standoff and underscore how scholars, market analysts and oil traders often overestimate the effect geopolitical events will have on prices.
For starters, Iran and Saudi Arabia have been at loggerheads since Iran's 1979 revolution, with Tehran intermittently trying to undermine the Saudi regime. The last thing Sunni-dominated Saudi Arabia wants is a nuclear Shiite Iran to which it would have to kowtow. The Saudis are ready to use their spare and idle oil capacity to make up for any disruption in the 2.4 million barrels Iran exports per day, as the Saudi oil minister recently noted.
In the event of war, it is almost certain that the United States would co-ordinate an oil release with the International Energy Agency. The agency requires each of its 28 members to hold enough oil in the form of international oil company stocks and/or strategic petroleum reserves to withstand a total cut-off of imports for 90 days. When the U.S.-led coalition attacked Iraqi forces in Kuwait in 1991, a U.S.- International Energy Agency joint release helped significantly lower world oil prices.
Even if the International Energy Agency does not act, the United States has strategic oil reserves it could release on its own. Energy agency members hold more than 1.6 billion barrels of oil, with the United States alone holding well over 700 million barrels. That capacity could be used to defray the loss of Iran's oil exports for many months. U.S. President Barack Obama referred to this capacity Friday when noting that new sanctions that target Iran's oil exports on Iran would not harm allies.
Recent tensions sparked fears that Iran would close the Strait of Hormuz, through which 17 per cent of the world's oil flows. Tehran can certainly disrupt oil transit, but, whatever its threats, it does not have the capability to challenge the U.S. navy for long. Such a fight would be one of history's biggest mismatches.
Another concern is that the terror groups Hamas and Hezbollah, which are linked to Iran and sometimes viewed as its proxies, would attack Israel if the Jewish state or the United States strikes Iran. That is quite possible. But such conflicts have little to do with oil disruptions. Oil traders would eventually understand that an Israeli border conflict means little for oil prices unless it triggers a wider Middle East battle, such as the 1973 Arab-Israeli war. The chances of that are slim unless one believes that Sunni, Arab Egypt - a state in chaos - would suddenly align with Shiite, Persian Iran, an unprecedented alliance. And without Egypt, a broader war is not possible.
Those concerned about the fallout of a war with Iran should also consider that Libya's oil exports, which were cut off from February to October last year during the revolt against Moammar Gadhafi, are likely to reach preconflict levels in the next three to six months. That is one less constraint on the global oil supply.
We should also consider that Europe's economic woes, the lacklustre U.S. economy and China's slowing rate of growth are restraining the global demand for oil. Prices would jump much more if an Iran war coincided with higher global economic growth and oil demand.
And what of oil speculators? They are driving prices higher, hoping to make a quick buck on rate changes. Anticipatory creatures, they often buy on the rumour and sell on the news. Speculators would probably start to sell oil futures as war breaks out, seeking to cash in on their bets. This is another factor that would cause prices to fall.
Would all these conditions remain the same if Israel, and not the United States, were to attack Iran? Probably, because the United States, the International Energy Agency and Saudi Arabia are committed to price stability during major crises and because markets will work regardless of antagonists. The Saudis would act in part because they want to see Iran fail. And Washington would probably be dragged into any conflict.
During the past two decades, oil traders and security analysts have repeatedly overestimated the effect global crises would have on oil prices. Last year, for example, it was feared that the Arab Spring would undermine the Saudi regime and drive oil prices through the roof - and this never happened. Consider, too, that Turkey's invasion of northern Iraq in 2008, to squash the Kurdish rebels, drove oil prices higher - even though the action had no impact on oil supply and delivery.
The potential crisis with Iran may well turn out to be another example of exaggerated fears. If war comes, oil prices will surely rise. But contrary to conventional wisdom, they are not likely to stay high for long.
Copyright 2012 Metroland Media Group Ltd. All Rights Reserved.
(Originally published April 3, 2012, in the Guelph Mercury.)