Seeking Alpha

Oil To Go Up As Iran Plays Turkey-U.S.-Saudi Split

|
Includes: BNO, DBO, DNO, DTO, DWT, OIL, OILD, OILK, OILU, OILX, OLEM, OLO, SCO, SZO, UCO, USAI, USL, USO, USOD, USOI, USOU, UWT, WTID, WTIU
by: Seeking Vol
Summary

Straining U.S.-Saudi and U.S.-Turkey relations shifts the power calculations in the Middle East.

Turmoil in the Middle East, especially involving Iran, creates upward pressure on petroleum prices.

Expect greater short term volatility and upward trending oil prices.

Background

Saudi Arabia relies on its American-made military hardware to assert its military power in the Middle East and its main opponent in the region is Iran. The rivalry between these two large, well-armed, petroleum producing nations takes roots in religious conflict. This rivalry is manifested across the Middle East as each nation often backs different armed groups, from Yemen to Syria.

At the core of the rivalry is the Sunni-Shia split, dating to the time that a successor to Mohammed had to be chosen following his death. Two factions emerged backing different successors. The details are out of the scope of this article, but suffice to know that revenge has fuelled most of the strife between the two main branches of Islam since the murder of Ali by the ruling caliph in 680AD.

In 1932, the majority of the Arabian Peninsula is unified by the House of Saud and this becomes the birth of modern Saudi Arabia. In order to unify the peninsula and its disparate people, an alliance was formed with Wahhabi clerics who ascribe to a particularly orthodox interpretation of Sunni Islam. Some of the holiest sites of Islam, like Mecca, are in Saudi Arabia, and this obviously complicates matters for geostrategic Shia rival Iran.

Modern Iran comes from an Islamic revolution which deposed the Shah (like a king) that was ruling Persia with the backing of Western powers. The revolution was both as a means of shunning corrupting Western values and to reassert the sovereignty of the country. While Persia was ruled by a Persian, he was seen as neo-colonialist puppet selling out the country to the West. In 1953, the US collaborated with the UK to oust the democratically elected Prime Minister (Mosaddegh) who wanted to nationalise the Western oil interests in the country. When the preferred Prime Minister was installed, the Kingdom of Persia became authoritarian, with a brutal secret police established to crush dissent. In 1979, the Iranian Revolution installed a Shia cleric as supreme leader (Khomeini) and guardian of the faith, the moral rectitude of the country, and the revolution.

There continues to be deep hatred for the US due not only to its implications in removing from power a democratically-elected leader who threatened British commercial interests, but also for its assistance during the Iran-Iraq war to Iraq, which had attacked the newly formed Islamic Republic. In addition, the US backs Saudi Arabia and Israel militarily, both of which are sworn enemies. If Iran can make things complicated for the US, you can be fairly certain it will.

The threat to petroleum markets by Iran is not due today to its threats to nationalize foreign extractive companies and instead rooted in its capacity to disrupt international oil flows. In 1988, a US warship struck an Iranian naval mine in the Persian Gulf. It is precisely the fear that Iran will close off the strait of Hormuz -- through which a third of the world's oil passes in a shipping lane as narrow as 2 miles -- which allows Iran to balance out the US and its allies in the region. The US routinely performs freedom of navigation patrols and the US Navy is routinely harassed by Iranian drones. There are also conflicts at sea and it could be argued that the new littoral combat ships that the US is building are in response to the Iranian navy's speedboat swarm tactics. But thankfully, there is no open conflict so far.

Strait of Hormuz

The strait of Hormuz. Wikimedia Commons

The lose-lose US choice and opportunity for Iran

As European powers are attempting to salvage the Iran nuclear deal from which the US pulled out under President Trump, an opportunity for Iran to exploit divisions within NATO powers and the US web of allies is arising.

While Saudi Arabia has some history of executing Shia clerics (eg: al-Nimr in 2016) and taking actions that inflame strife with the other regional power across the Gulf, the Kingdom has so far had the unequivocal backing of the US and therefore conflict has been limited to fighting through proxies. The balance of power in the Middle East has so far kept Iran officially contained in its borders, even if it has been funding groups to expand its influence in the region, like Hezbollah and Hamas. In Syria, Iran has been operating in collaboration with the Syrian government forces, which have clashed with forces backed by Turkey and Saudi Arabia (notably the Free Syrian Army) and with forces backed by the US and other NATO allies (notably the Syrian Democratic Forces).

One should recall that Turkey is a member of NATO since 1952 but recently there has been a number of events that has led to its estrangement. The purchase of Russian-made air defences and the sanctions that President Trump has applied on a close ally to coerce the release of a pastor do not augur well. And now as the supposed Turkish recording of a gruesome state-ordered murder makes news around the world, the Trump administration is confronted to an awful choice: support Saudi Arabia and put down Turkey, or support Turkey and dress down Saudi Arabia.

The dilemma facing the US at the moment on whom to believe and whom to condemn opens up an opportunity for adversaries from or operating in the Middle East, notably Russia and Iran, to exploit the widening hole in the US-led web of alliances which has contained their aspirations. Should the US come down on the side of Turkey, Saudi Arabia will be increasingly isolated, which ought to tempt Iran to increase its efforts in Yemen and Iraq, and perhaps embolden it in the Gulf. In this case, one can expect greater turmoil in the Middle East and, consequently, greater uncertainty on oil supplies which translates into higher prices.

On the other hand, if the US comes down on the side of Saudi Arabia, the fact that it is a journalist that disappeared and was allegedly murdered, increases the perception of approval of authoritarianism (and state-sanctioned murder of political dissenters) which would deal a terrible blow to the international credibility of the US as the leader of the free world. I would expect for violence in Syria to flare up and become more brutal because protestations by the US of human rights abuses would ring hollow. This would renew global focus on the Syrian civil war and would increase the likelihood (and fear) of American and Iranian clashes there, which would lead to retaliation elsewhere, such as in the Persian Gulf.

Regardless of which way the Trump administration falls on this issue, the situation is forcing it to choose one ally over another. This split between allies may be large enough for Iran to drive a wedge for its own strategic gains. Military forces may be involved but as one will recall from the 1970s, there's always the Oil Weapon. I'd expect greater volatility with upward-trending Oil (USO) prices for the next few months.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in USO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.