Is This What Winning Looks Like?

“Let me say, we’ve won” said US President Donald J Trump on Wednesday. He followed this up with, “You never like to say too early you won. But, we won – in the first hour it was over!” Reports soon emerged that Iran’s Supreme Leader Ali Khamenei had been killed in the opening phase of the conflict. His son, who replaces him, survived with injuries but his wife and one of his sons were killed. He may not be in the mood for mediation or de-escalation at this point.

The oil market initially responded positively to US administration figures talking about a short war, with prices falling back through $100 almost as quickly as they had climbed. But then Iran claimed to have mined the Strait of Hormuz and said that the Strait is closed and oil is back at $100 per barrel. Oil and gas facilities continue to be shuttered. The attacks on international assets continue.

Here is a summary of the vessels hit so far:

Here is a summary of the oil terminals hit so far:

Iran also claims to have hit the 200k bpd Haifa oil terminal and refinery but there has been no confirmation of this.

These attacks are a tragedy for the seafarers and shoreside workers caught up in the conflict. But they also point to an escalation to a geographic pattern of direct energy system attacks on both sides, with direct effects on global shipping and energy markets. The news is growing about disrupted commercial and personal travel and airline losses, about rising inflation, about the ramifications for fertiliser and medicine costs (both rely on oil and gas as feedstocks), and the hit to regional GDP in the GCC countries.

The US seems to be trying two things simultaneously now – to keep the pressure on Iran but ease the economic pressure from disrupted energy flows. Millions of barrels of oil have been released from IEA member state reserves. But they won’t last for ever, and my take is that this war will go on far longer than the US would like.

Here are three scenarios for the war, all of which come with higher costs for us all.

Scenario 1: Walk away, come back later.

Mr Trump could declare “Mission accomplished” and turn the fleet around today, but would that stop Iran from firing on its neighbours and on Israel? The new Supreme Leader might be taking this personally and have ideas about revenge.

Last year, after Mr Trump had declared that the Houthi faction in Yemen had “capitulated” they kept firing and the Red Sea / Suez route remains mostly under-utilised today.

The same could happen to the Middle East Gulf – no direct conflict but an effective no-go zone for most shipping. An economic catastrophe would befall the region’s oil and gas exporters.

In this scenario, oil prices would stay well north of $100. Consumer nations would accelerate their energy transitions to minimise reliance on hydrocarbons. The petrodollar would suffer a lack of demand, adding to US national debt costs.

If the US leaves, it leaves Israel to fight on alone against a largely unchanged, possibly more hostile Iranian regime which may be more than ever determined to get its hands on the ultimate deterrent. Regional instability is practically guaranteed to continue.

You might say, the oil and gas will find new ways out. And indeed Saudi Arabia is diverting oil to its Red Sea terminal at Yanbu. The Arab Times reported yesterday that 25 tankers are racing there to load 50 Mn barrels of crude (which implies they are 2 Mn barrel capacity VLCCs). But those ships are sailing right past the Bab el Mandeb – the Houthi’s shooting gallery. And the Houthis remain allied to Iran.

In this scenario, the US would end up coming back, which is precisely what Mr Trump said he did not want to do. So the war goes on.

Scenario 2: Keep going and reopen the Strait of Hormuz

The definition-tightening has been ongoing, as regime change has been replaced by destroying Iran’s navy, its nuclear program, and its ability to fight beyond its own borders. Mr Trump gets to “finish the job” but avoid a long and bloody ground war.

In this scenario, the US also demines the Strait of Hormuz and provides the reinsurance backstop to keep shipping moving in and out of the gulf. I have seen cost estimates of up to $500 billion for the reinsurance. With a modern VLCC theoretically worth north of $150 million given its current cashflow potential, insurance costs are rising fast. It’s also worth noting that, according to Reuters, the US Navy said escorts for all commercial shipping were not feasible, so the US cannot simply “solve” the shipping problem with convoy protection alone.

In this scenario Iran’s regime remains in place but very much weakened. The country, economically ruined, begins to resemble Syria, with a regime-controlled core focused on Tehran but less control over restive regions further away. Iran’s oil exports could falter, like Libya’s have over the last decade. Political instability could lead to more piracy and political violence across the region, raising costs for shipping and neighbouring energy exporters.

In this scenario, nations which have become reliant on gulf energy exports still pivot away from hydrocarbons faster in order to avoid being brought to the brink in future. GCC energy exports do not recover to pre-war levels, which in turn cuts investment. The UAE loses some of its lustre as a financial hub and as a stable and safe low tax environment for expats. The GDP shock to the region is significant and lasting. The US and / or other military navies end up providing security in the region for years at significant cost.

Alternatively, Iran’s regime bounces back quickly with reconstruction support from e.g. China. And even if Iran publicly renounces any ambition to build a nuclear weapon, it could potentially acquire one from a third party. As the war was fought to prevent Iran acquiring nuclear weapons, this would surely count as a defeat for the US. Therefore this scenario is a non-starter.

Scenario 3: Pivot to diplomacy

I have seen commentators call for a mediator with good links to all participants, such as India’s Prime Minister Modi. In this scenario, both sides are offered an off-ramp, while Iran renounces its nuclear ambitions and allows continuous inspection of its facilities. Russia and China would back this scenario and most US administrations would keep back channels open to give it some air. But right now it seems like both sides in this war see a better outcome for themselves after more violence. So the war goes on.

The US is now fighting two wars: a kinetic war against Iran and an economic war to head off the global consequences of its kinetic war. It is becoming apparent that the economic effects of the conflict go way beyond a short period of higher gasoline prices. Thus the second war may be harder to win than the first.

In each scenario, the short-term spike in energy freight markets lasts for as long as the kinetic war continues. It is replaced by mid-term instability and volatility, adding to cargo owner costs which pass through to higher inflation in energy consuming nations. Longer term, those nations accelerate the energy transition, causing lower demand growth and lower earnings for oil and gas tankers.

What is astonishing is the speed with which the consensus view of just a few weeks ago – falling oil prices, well-supplied energy markets and stronger global GDP growth – has unravelled. The short-term spike in tanker freight could be replaced by a more disrupted, higher-cost future of slower demand growth and lower earnings. The oil and gas tanker markets might enjoy today’s income spike, but could end up as long-term collateral damage.

Wars often begin with confidence. They rarely end the way that anyone expects.

Substack post: https://shippingstrategy.substack.com/p/is-this-what-winning-looks-like

Source: Shipping Strategy by Mark A P Williams