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What a War Involving US, Israel, and Iran Means for Oil

|Includes:CRUD, GLD, OLO, The United States Oil ETF, LP (USO)

 Concerns of a war between Israel and Iran starting this month (August 2010) that would lead to a wider war have been growing. In this blog I will outline the scenario as well as my thoughts on some implications a war would have on the markets.

I: Is War Really Likely? 

Former US FBI Special Agent and Time Magazine's 2002 Person of the Year Coleen Rowley wrote an open letter to US President Obamawarning him of an Israeli attack on Iran that would lead to a wider war. The opening of her letter:

We write to alert you to the likelihood that Israel will attack Iran as early as this month. This would likely lead to a wider war.

Israel's leaders would calculate that once the battle is joined, it will be politically untenable for you to give anything less than unstinting support to Israel, no matter how the war started, and that U.S. troops and weaponry would flow freely. Wider war could eventually result in destruction of the state of Israel.
What has gotten far more media attention than Rowley's letter is an article in the US-based publication The Atlantic in which writer Jeffrey Goldberg claimed, after spending a year and a half interviewing current and past Israeli decision makers, that there is a greater than 50% chance of an Israeli attack on Iran within the next 12 months. 

II: How Will Iran Respond?

In a 36 page report (pdf) for Harvard University's International Security publication, Caitlin Talmadge asserted that the Iranian response may be to close the Strait of Hormuz. Below is the synopsis of Talmadge's report:
How might Iran retaliate in the aftermath of a limited Israeli or U.S. strike? The most economically devastating of Iran’s potential responses would be closure of the Strait of Hormuz. According to open-source order of battle data, as well as relevant analogies from military history and GIS maps, Iran does possess significant littoral warfare capabilities, including mines, antiship cruise missiles, and land-based air defense. If Iran were able to properly link these capabilities, it could halt or impede traffic in the Strait of Hormuz for a month or more. U.S. attempts to reopen the waterway likely would escalate rapidly into sustained, large-scale air and naval operations during which Iran could impose significant economic and military costs on the United States—even if Iranian operations were not successful in truly closing the strait. The aftermath of limited strikes on Iran would be complicated and costly, suggesting needed changes in U.S. force posture and energy policy.
The Strait of Hormuz is the world's most important point in the transit of oil supply throughout the world, with approximately 16.5-17 million barrels of oil per day being transported through it, according to the US Energy Information Administration. An Iranian response of shutting down the Strait of Hormuz would send a shock to the global oil supply. I would expect a supply contraction of this type to be bullish for the price of oil. 

If the war expands to include China and Venezuela, allies of Iran, the possibility of economic warfare resulting in a mass selling US Treasury bonds becomes more possible as well. I would view this as bearish for the US dollar, and bullish for precious metals. 

III: A Look at the Charts

Crude oil's rapid price collapse from its high of $147 in 2008 leaves a large zone where there are fewer strong resistance areas -- see the monthly chart below for the clearest illustration of this. I would expect fewer strong resistance levels, coupled with a global supply shock, to facilitate a rapid ascent in price if war occurs and if Iran responds by shutting down the Strait of Hormuz.

Below are the daily, weekly, and monthly charts. The daily chart in particular shows an inverted hammer at support after a downtrend; the case for bullishness will benefit if the market rallies from here. 




Disclosure: Long gold.