The financial market’s reaction to the escalation of tensions between the U.S. and Iran have so far been muted, even benign. A little over a week from the U.S. killing of top Iranian commander Qassem Soleimani and Iran’s response (missile attacks on U.S. army bases in Iraq), and a casual observer of financial markets would be hard pressed to see what all the fuss is about.
Taking market performance as a measure, there has been little visible dent to investors’ confidence from the most recent geopolitical flare up.
- Have market participants, irrespective of asset class, grown complacent to geopolitical risks, or have they decided that the overall threat to the global economy of further incremental deterioration in U.S.-Iranian relations and more broadly, Middle Eastern stability, is relatively contained?
- In the past, oil prices were the main transmission mechanism from major Gulf conflicts to the broader global economy and financial markets.
- However, the U.S. is now a net exporter of petroleum products, which was not the case during either the first or second Gulf War. The U.S. has essentially achieved energy independence and it can now use its own supplies to offset the impact of Middle Eastern supply shocks.
- It appears that oil market participants would need to see sustained physical market disruption to justify adding a significant risk premia to energy prices.
Geopolitical tensions between the US and Iran continued to send shockwaves through the commodity markets Monday, January 6, 2020, with oil prices breaking above the key $70/b level and gold and precious metals surging to multi-year highs as their role as safe havens comes to the fore.
Market risks have escalated following the U.S. killing of Iranian General Qassem Soleimani last week as participants weigh the potential for supply disruptions throughout key Middle East commodity hotspots, including shipping chokepoints, terminals and infrastructure. While there are heightened risks of retaliatory attacks around oil facilities in Saudi Arabia's Eastern Province, the uncertainty around how and when Iran will likely retaliate as threatened and where the conflict will go is spread across oil and other commodities, including LNG.
"Barring massive interruptions of oil supply from the aftermath of the US airstrike last Friday, Brent prices are likely to stay elevated but is unlikely to be above $70/b on a sustainable basis or for too long. We continue to believe see chances of a full-scale conflict in the Middle East leading to massive interruptions of oil supply as below 50/50 though things may change," S&P Global Platts Analytics said.
Sovereign Event Risk
S&P Global Ratings said on Monday that the killing of Iranian general Qassem Soleimani by the U.S. over the weekend and its ongoing fallout has rapidly escalated event risk in the Gulf region. For now, this development does not alter our base-case assumption that any military action by either side will not lead to a fully fledged direct military confrontation.
We continue to believe that any escalation will remain contained given that a direct conflict would be economically, socially, and politically destabilizing for the entire region, including U.S.-Gulf allies. We consider that a potential intensification of proxy conflicts will further undermine confidence and investment in the region. Our ratings on Gulf sovereigns already take into account a certain level of regional geopolitical volatility.
- If a protracted and wider conflict emerges, assuming export routes remain functional, the fiscal benefit of potentially higher oil prices for Gulf sovereigns will likely be offset by the adverse effect on capital outflows and weaker economic growth, in our view (see "How U.S.-Iran Tensions Might Affect Gulf Sovereign Ratings", published June 11, 2019).
- A further escalation could be especially destabilizing for Iraq's security situation, particularly if reprisal attacks take place in the country. However, the low rating level already incorporates a high degree of political risk and the deep-rooted challenges the country faces.
- We continue to believe that any escalation will remain contained given that a direct conflict would be economically, socially, and politically destabilizing for the entire region, including U.S.-Gulf allies. We consider that a potential intensification of proxy conflicts will further undermine confidence and investment in the region. Our ratings on Gulf sovereigns already take into account a certain level of regional geopolitical volatility.
Corporate Cyber Defenses
U.S. businesses and operators of major infrastructure such as power grids and dams could be targeted by Iran after the assassination of the Islamic republic's top military commander, Qassem Soleimani, in what could be corporate America's greatest cybersecurity challenge to date.
The U.S. Department of Homeland Security on Jan. 6 issued guidance urging companies to review security and emergency preparedness plans, back up critical information, and train staff on cybersecurity best practices. The department specifically noted Iran's targeting of finance, telecom and energy, and its heightened interest in industrial control systems and operational technology.
- Iran has a history when it comes to cyber aggression.
- Despite major advances in corporate cyber defense in the intervening years, U.S. companies remain vulnerable to exploitation by the most sophisticated state actors, particularly those in the energy, telecoms and finance space, according to James Lewis, senior vice president and director of the technology policy program for the Center for Strategic and International Studies in Washington.
- Cyber warfare offers another route through which Iran can carry out deniable attacks and expand its reach even further geographically. It also reduces the risk of physical harm to U.S. troops and civilians and makes it difficult for the U.S. to justify a military response.
- Cyberattacks are not without risks. Even if successful, they could prompt retaliation from the U.S., which is thought to have carried out a number of cyber operations against Iran in recent years, most famously an alleged attack on the nation's uranium enrichment program via Stuxnet in 2009.
Calls for Calm
Iranian foreign minister Javad Zarif has made a peace overture to Gulf countries, lamenting the lack of intra-regional dialog, as Saudi Arabia reiterated the need for calm and de-escalation of tensions in the wake of the killing of a top Iranian commander last week.
Calls for calm have emerged from several Gulf states, including Saudi Arabia and the UAE, OPEC's biggest and third-largest oil producers respectively, since the killing of Qassem Soleimani in Baghdad.
- Saudi deputy defense minister Khalid bin Salman met with U.S. Secretary of Defense Mark Esper and Secretary of State Michael Pompeo in Washington on Monday as part of efforts to defuse rising tensions in the region.
- Separately, Iran's Supreme National Security Council disavowed statements attributed to the body's secretary on Tuesday, in which he said the country was considering 13 scenarios in retaliation for Soleimani's killing.
- Iran's parliament also on Tuesday passed legislation designating the Pentagon and the U.S. military as "terrorist" organizations, state-run IRNA news agency reported.
The U.S. Maritime Administration has issued an advisory warning of the possibility of Iranian attacks on U.S. ships in Middle Eastern waters after a U.S. military strike in Baghdad on Friday killed atop Iranian commander, Qassem Soleimani, fueling tensions in the region and heightening concerns about disruption to oil supplies.
The U.S. Fifth Fleet, which is based in Bahrain, polices the Strait of Hormuz and the other important waterways in the region. Iran has reiterated its threat to retaliate to the U.S. strike after U.S. President Donald Trump vowed to hit 52 Iranian sites if Tehran strikes back.
The U.S.-Iran standoff has sent oil prices soaring to touch $70/b on Monday for the first time since September amid fears of the crisis disrupting oil supplies from the Middle East. Brent retreated on Tuesday, with prices falling 0.64% to $68.47/b at 11:19 AM GMT.
U.S. in Middle East
Iran's Supreme Leader Ayatollah Ali Khamenei said Wednesday that the U.S. should leave the Middle East after the U.S. killing of a top Iranian military general last week.
"An important incident has taken place," Khamenei said in a televised speech in Iran, after Iran attacked two U.S. military bases in Iraq on Wednesday. "The issue of revenge is something else. The Americans brought war, sedition and ruins - the negotiation and sitting behind tables is a prelude for their interference which should end."
- Iranian state TV said Tehran had made the attacks in Iraq in retaliation for last week's US drone strike in Baghdad that killed General Qassem Soleimani. Bases in Ain al Asad and Erbil were attacked, a spokesman for the Islamic Revolutionary Guard Corps said, according to Tasnim news agency.
- Iranian President Hassan Rouhani told the Iranian Cabinet on Wednesday that Iran wants the US to leave the Middle East region. "If the US feet is cut from this region, and its aggressive hand is cut forever, it will be the real revenge and final response of the nations in the region to the US," Rouhani said, according to state television.
The cost to deliver commodities is set to rise as additional war risk premia on merchant ships in the Middle East has shot up significantly this week, while security concerns are prompting some shipowners to temporarily steer clear of the Persian Gulf, market participants said Wednesday.
Some of the owners are not prepared for their ships to dock at ports in the Persian Gulf, while others are adopting a "wait and watch" attitude, several sources in London, Dubai, Singapore, Seoul and Tokyo said.
- The Strait of Hormuz, which leads to the Persian Gulf, is a critical choke point through which 30% of the world's seaborne oil passes through.
- Owners who are still prepared to load, bunker or transit in the Persian Gulf, are requesting charterers to bear the cost of risk.
- "The war risks insurance market for ships transiting the Persian Gulf has started moving upwards with some insurers already charging higher premiums," an insurance executive tracking such deals said. Others are waiting to see whether the current tensions translates into an actual enhanced threat against shipping, the executive said.
- Traders and shipping industry officials are on the edge for fear the Iran-US melee may escalate into a wider conflict. If this happens, the cost of moving cargoes will rise further.
The killing of Major General Qassim Soleimani, Iran’s top hardline military leader, has put oil prices and the fragile stability of the Middle East once again on tenterhooks.
Crude jumped 4.9% to almost $69.50/b on Friday after a US drone strike in Baghdad killed Soleimani on foreign soil. Oil traders are now weighing the scale and ferocity of Tehran’s inevitable response.
- Higher prices reflect the fear that Iran will lash out immediately at the oil facilities of its enemies in the region, or hit tanker traffic in the Strait of Hormuz. However, a broader direct military confrontation between the U.S. and Tehran in the Middle East would have an even bigger impact on energy trade flows in a region that produces a fifth of the world’s oil.
- As head of the elite Quds brigade of the Iranian Revolutionary Guard Corp, Soleimani was seen as the biggest single threat to U.S. foreign policy interests in the region.
- Tensions and security are already high around oil, which has become a target over the last 12 months in the Persian Gulf and its key shipping lanes.