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Door Opens for De-Escalation With Iran

Door Opens for De-Escalation With Iran

  • 01.09.20
  • Economy & Policy
  • Article

Washington Policy Analyst Ed Mills and Energy Analyst Pavel Molchanov discuss U.S.-Iran tensions as well as the likely impact for oil.

President Trump is pivoting to limiting Iran’s nuclear capabilities and increasing sanctions following Tuesday night's missile attack on U.S. bases in Iraq, limiting further escalation potential in the near-term. Trump categorized Iran’s posturing as “standing down” and indicated the U.S. is evaluating “all options,” but next steps are expected to focus on limiting further aggressive actions by Iran and possibly even set the stage for a return to negotiations.

The de-escalation potential is enhanced going forward and is likely to focus on increasing coordination between the U.S. and the EU on the Iranian nuclear issue rather than direct military tit-for-tat between the U.S. and Iran. However, the medium-term risk of Iranian tensions flaring up remains elevated, as the missile attacks are unlikely to be the only form of Iranian retaliation to the U.S. strike against General Soleimani.

Trump confirms no imminent retaliation by U.S. forces

President Trump’s statement on Wednesday opened with an assertion that Iran will not be allowed to develop a nuclear weapon – echoing long-standing U.S. policy, across numerous administrations – which we view as a sign that the U.S. is refocusing on longer-term strategic objectives rather than near-term military action in response to Iran’s missile strikes against U.S. bases.

The President’s red line of harm to U.S. personnel is maintained as Trump assigned significant importance to the fact that there were no U.S. casualties following Iran’s strikes. The near-term focus for the administration will be implementing harsher economic sanctions to further disincentivize malign behavior while increasing coordination with NATO and the EU. Trump called on EU countries to leave the Iranian nuclear deal, which may lead to increased pressure tactics on the EU to better align them to the U.S. objectives, as we have seen historically. Trump will also seek to increase NATO’s involvement in the Middle East, which may be seen as a politically favorable move in order to limit harm to U.S. forces in the region and broadly increase lawmakers’ support for the direction of U.S. policy against Iran. Although we are now at a point where de-escalation appears likely, tensions are primed to re-escalate significantly if Iran takes any further action.

Stage is set for de-escalation

Ever since the U.S. killed Iran’s Gen. Soleimani last Friday, a key question has been: what form would Iran’s retaliation take? In the early hours of Wednesday morning, the answer became clear: limited missile strikes against two U.S. military bases in Iraq.

The retaliation was notable in two ways. First, there were no U.S. casualties, perhaps in part because of prior warning given by Iran to the Iraqi government. This reduces pressure on the White House to respond – thereby creating a realistic off-ramp scenario, enabling de-escalation - as Trump's statement confirmed. Second, the conflict has remained limited to the military dimension: neither side appears to want to broaden the conflict into civilian / economic targets. As such, there is no imminent prospect of impact on oil supply.

Physical impact on oil supply is unlikely

Bearing in mind what we wrote above about the limited, restrained nature of this conflict, we are not sensing any appetite, from either side, to seriously escalate the situation by starting to deliberately target civilian sites, including economic or industrial facilities. In particular, Iran could have struck oil infrastructure in Saudi Arabia or other Gulf states, or foreign tankers in adjacent waterways, or – as the most extreme scenario – mined the Strait of Hormuz. However, Iran has not done any of these things.

Recent comments to CNN by the Supreme Leader’s military adviser also attest to Iran’s intention to refrain from attacking civilian sites. To be sure, any military altercation, however limited, carries the risk of miscalculation or accident. But, based on the latest developments, physical impact on oil supply in the region represents an unlikely scenario. In this context, the futures curve remains backwardated (downward sloping), with Brent futures for December 2020 currently at $62 per barrel, versus the spot price of $67 per barrel. For context, our full-year 2020 forecast is $70 per barrel.