That’s why Iran is a risk: a disruption would make oil markets even tighter, and drive gasoline prices up further. Even before the February spike, gasoline prices relative to earnings and income were starting to bite (2"' chart). The private sector can handle some gasoline price increases, but probably not much more than what we’ve seen already. The spread between retail and wholesale gasoline prices is low ($0.35, compared to a $0.35-$1.00 range), suggesting further retail increases may be in store.
People like me now spend a lot of time on conference calls with geopolitical experts of different stripes. On one call, speakers raised the probability of military action from 30% to 50%. On another call, speakers mentioned that the US has “tun out of senior military advisors to send to Israel, all requesting that Israel not attack unilaterally”, and believe Israel won’t. A paper by Matt Kroenig in Foreign Affairs magazine entitled “Time to Attack Iran; Why a Strike is the Least Bad Option” resulted in a firestorm of criticism from multiple sides. With sanctions appearing to work (Iran’s inflation, currency collapse, fewer buyers of its oil and a potential ban on Iranian banks from the global SWIFT payments network), won’t the US want to wait and see? Most of the US military establishment seems to take this view. The conjecture is endless. Here are a few points I found to be of greatest relevance as we sift through this:
** The US and Europe appear to take the Israeli attack threat seriously. Economic recoveries are just beginning to form in both regions, and there are elections coming up, so for politicians to ratchet up sanctions and drive up oil and gasoline prices, they must be very concerned that without tougher sanctions, the Israelis might act.
** Tran’s Fordow facility is key to understanding the debate about the effectiveness of military action, and why some are nervous that the “window for action is closing”. Fordow is estimated to be 80-90 meters below grade, and is suspected of being ready for uranium enrichment. The Iranians reportedly have ~80 kg of 20% enriched uranium (UF), and need 25 kg more to convert it into enough uranium metal (UF4) for a nuclear bomb. The most powerful conventional weapon in the US arsenal is the Massive Ordnance Penetration device (MOP), a 30,000 pound bomb with 5,000 pounds of explosives. It travels at twice the speed of sound, and is designed to penetrate rock and concrete before
detonating. However, it would probably take 4 of these weapons, dropped in succession by B-2 bombers in the same exact spot, to destroy Fordow [a].
** Military strikes could quickly escalate to engulf the entire region. While the Israel-Iran and US-Iran dimensions are important to understand, so too are the Sunni-Shia issues in play. Any complicity by Sunni countries in conjunction with US action (airspace, attack plans and logistics, etc.) might be seen as acts of war by Iran.
** The Strait of Hormuz carries 20% of the world’s oil (17 million bpd). There are active and de-activated pipelines in Saudi Arabia, Iraq and the UAE that could divert around 5-6 mm bpd, and strategic petroleum reserves could be released. Even so, a military battle in the Strait could cause oil prices to rise $20-$30, according to EIA and GAO 2007 estimates.
To be fair to all the analysts, journalists and think tanks, there is no reason to expect greater foresight now than during the Cuban Missile Crisis, Iraq War or other military standoffs. This is a binary market risk that in our view justifies material consideration in portfolio allocations, and that’s about all we know. Our 2012 Outlook section on this issue was entitled “Learning to Live with a Nuclear Iran”, and that may very well be where this ends up.
HOUSE_OVERSIGHT_031147