This could mean War with Iran

Iranian threats to close the Strait of Hormuz, the narrow shipping channel through which 17 million barrels per day of Middle East oil exports pass, has put, for the moment, a war premium into the oil price. The Iranians are reacting, in part, to the continued shadow war on their nuclear program. That war claimed another Iranian scientist recently in a scene straight out of a James Bond film.

But here’s the thing… In an integrated global economy with long energy and commodity supply chains, the cost of an actual shooting war between nations is increasingly prohibitive. War with Iran, at least a conventional war with cruise missiles and naval battles and an invasion, is unlikely.

I realize this might be a dangerous and complacent idea. Many people probably thought the same thing in Europe on the eve of the First World War. The world was so prosperous and interconnected under a gold standard that war seemed unimaginable. Worse, war – even over scarce resources – seemed like a willful act of self-destruction.

War with Iran?

From a strictly psychological point of view, human beings take self-destructive action all the time. There’s no rule against it. But what about nation states? Will the United States really bomb Iran to try and prevent that country from building an atomic weapon? Will Iran’s ruling regime invite certain destruction by closing the Strait of Hormuz to oil exports, or trying to?

For many reasons, I think the answer is no.

According to the New York Times

Oil analysts say Saudi Arabia, Kuwait and the United Arab Emirates, all allies of the United States in confronting Iran, would be able to replace up to two-thirds of Iran’s 2.2 million barrels a day of oil exports that anchor the Iranian economy with annual revenues of roughly $75 billion a year. But the analysts caution that they could only sustain the additional output for a limited amount of time through increased production and tapping stored reserves estimated at 30 million barrels. They also warn that eventually, oil prices would rise threatening the shaky global economy.

In the middle of a banking and economic crisis, the last thing the Western world needs is an oil crisis. It would be an “own goal” of epic proportions for the West to take action that resulted in oil reaching $200 a barrel – even if it were for just a few days or weeks. It would shock the world into a severe recession.

As a side-note, Saudi Arabia has always been the swing-player in times like this. It’s traditionally had excess production capacity it could use as leverage to raise oil production and bring down prices when its American ally wanted to do some sabre rattling in the region. But the Saudis are out of spare capacity.

According to CNBC

Top oil exporter Saudi Arabia is nearing its comfortable operational production limits and may struggle to do much to make up for shortages that arise from new sanctions imposed on Iran by the West, Gulf-based sources said…Long-standing oil policy by Riyadh, the heavyweight in the Organization of the Petroleum Exporting Countries (OPEC), sets aside some 1.5 million bpd as protective spare capacity. But industry sources said pumping anywhere near the declared production capacity might involve extracting heavy crudes the market might not want.

This is one of the issues I explored in Revolution in the Desert. The Saudis began drilling for shale gas last year. There is still plenty of oil left, to be sure. But 2011 was the year natural gas became just as strategically valuable as oil.

In the meantime, the Saudis may be looking for a new strategic patron as well. The US has less interest in going to war with Iran to curb its regional ambitions because, in simple terms, the US doesn’t need Mideast oil as much as it used to.

According to Bloomberg

The U.S. now gets only about 9 percent of the oil it consumes from the Persian Gulf. Countries such as China, India, Japan and South Korea, however, rely on Gulf exports, particularly from Iran, to power their economies. In the European Union, debt-ridden Greece gets 14 percent of its oil imports from Iran, Italy 13 percent and Spain almost 10 percent.

If you couple less US-reliance on Gulf oil with heavy Asian and European reliance and you get a situation where “asymmetric” warfare with Iran will continue, but a shooting war won’t start.

What is Asymmetric Warfare?

Well, in investment terms, asymmetric warfare is a non-military kind of conflict in which the returns on investment (ROI) are incredibly high. For example, the 9-11 attacks were not directed at a military target. Yet they inflicted massive damage on the United States economy, currency, and financial system, not to mention they led the US into two trillion-dollar wars that have bled national resources at a time the US government was already facing a fiscal firestorm.

The Obama Administration’s US Strategic outlook mentions asymmetric warfare. It does not mention, of course, that the US has probably been using it against Iran for several years now. But it does say…

Sophisticated adversaries will use asymmetric capabilities, to include electronic and cyber warfare, ballistic and cruise missiles, advanced air defences, mining, and other methods, to complicate our operational calculus. States such as China and Iran will continue to pursue asymmetric means to counter our power projection capabilities, while the proliferation of sophisticated weapons and technology will extend to non-state actors as well.

You’ll note both China and Iran are mentioned by name.

Nation States are interested in their own survival. Unless attacking another State promotes survival – for example as a way of directing internal anger and unrest against external enemies – I would expect most governments to pursue war by other means: currency wars, economic warfare, cyber warfare, industrial espionage, and asymmetric warfare, perhaps outsourced to non-state actors who can’t be traced back to the patron State.

None of this is encouraging, of course. But it is what it is. For financial markets, it’s a version of the muddle through the European Central Bank is trying to force on everyone. The logic of the muddle through is that a cataclysmic/cathartic event (like the bankruptcy of Lehman Brothers or the invasion of Iraq in 2003) is too destructive to let happen again.

Any alternative – the endless expansion of central bank balance sheets or targeted assassinations of nuclear scientists in Iran to kick the proliferation can down the road – is preferable to an actual crisis.

This is why 2012 could be the year in which all the world’s stock markets become Japanified. That is, the debt overhang is never liquidated in the banking system but simply absorbed and moved around between banks and the government, producing a slow-motion zombie transformation.

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