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Possible Reaction Scenarios To A Preemptive Israeli Strike On Iran

Bradley Schaeffer
Zero Hedge
July 25, 2010

I have written in the past about the prospect of a nuclear Iran and its destabilizing effect in the world’s most important energy region.  But what if Israel strikes before Tehran’s nuclear ambitions are realized?  Although given that Iran currently could have as many as 8,000 centrifuges enriching uranium by December (IAEA estimate),  an Israeli strike now, as opposed to say 2003 when the secret program was first revealed, may not effectively shut down the decentralized program.  Still, it could cause a frustrating delay in Iran’s timetable and, depending on the line the mullahs take immediately succeeding the attack, weaken the regime’s hold on a populace that is more educated, more worldly, more pro-Western and less easily cowed than others in the region as the green protests last year revealed.

The (literally) billion dollar question of course for commodities traders  is what will be the effect on the price of global energy in the immediate and longer dated aftermath of such a military strike?  As with the current diplomatic stand-off today, much of that will depend on Tehran’s reaction.  Here are three possible scenarios should we wake up to news of Israeli fighter-bombers winging away from Natanz, leaving a burning nuclear facility and a thousand questions in their jet wash behind them.

Best case scenario: Iran plays the victim.  Instead of striking back militarily, Iran uses the attack to show the world that Israel and her puppet-master the United States are the aggressors.  The mullahs may even use such an attack to shore up their public support at home. “It may make sense for the Iranians to play the victim,” said IHS Global Insight Middle East analyst Gala Riani. “They may also use it to build the regime’s legitimacy internally.”  Sure, they would angrily denounce the criminal raids, invite the international press to view the destroyed buildings and, of course, the hospitals treating the inevitable civilian casualties and the very public funerals that would follow.  But in the end, especially if the damage is minimal, they may try to turn this military lemon into p.r. lemonade.  I would expect a mild knee-jerk rally in crude oil (depending on the base price at the time of the strike).  Call it $5.00 to $15.00 but I think any rally will be brief and a selling/shorting opportunity if anything.

Mid-case scenarios:  Iran could retaliate in one of two-ways (or both) short of major escalation of violence.  They could intensify their proxy war against the United States and her allies in Afghanistan and Iraq as well as Israel in Lebanon and the Palestinian territories through Hezbollah and Hamas respectively.  Such actions’ short-term impact could have a similar impact on crude prices as the best-case victim scenario, especially if the attacks focus on Israel which is already under the gun so to speak.  Although Israel has threatened to hold Syria and Lebanon responsible for any Hezbollah attacks, in the end it will be the intensity of the attacks and level U.S. support for retaliatory actions that will determine the degree of escalation such a declaration could imply.

It must be noted however that should there be a marked increase in violence against Western forces, especially beyond the immediate areas of Gulf conflict, and particularly militant-launched attacks on oil-focused targets such as refineries, pipelines, and the like, global tensions could rise quickly.  This is especially true if Israel waits until the new year when a more friendly Republican-controlled Congress (if predictions hold that is) may press the tepid Obama administration for a more punishing response to Tehran’s machinations.  In this case we could see oil’s floor set at perhaps $10-$20 or more higher than pre-strike levels and remain there for some time.

Worst-case scenario:  Iran could react with great force, launching conventional warheads against Israeli targets while at the same time following through with its threat to close the Strait of Hormuz and choke off the most important maritime route through which 17 million barrels of crude oil move each day.  The immediate supply shock would send oil futures spiraling into the $140+ range (roughly double where they are now).   “Iran doesn’t even need to be successful in their threat,” said Michael Wittner, global head of energy research at Societe Generale. “Even a credible threat or near miss and insurance rates will spike. Then no one’s going to send any oil through there for a couple of weeks until somebody’s navy can re-establish control.”

Should the Iranians actually attempt to close the narrow sea lanes over which they frown, the United States Navy will be compelled to re-open them by force.  This will unleash unintended consequences that are anyone’s best guess.  Although Iran’s ability to maintain a blockade in the face of the most powerful navy in history is in doubt, certainly the price spike will hold as insurance rates skyrocket for a time and such costs are passed on to consumers.  Also re-routing the oil overland or drawing it from other regions will entail higher transportation costs and risks of their own.

Commodities derivatives are driven by uncertainty.  They are, in fact, risk management instruments to be used to mitigate uncertainties in just such scenarios as described above.  Uncertainty is inherently bullish.  I cannot conceive of a scenario in which oil prices will fall in the event of an Israeli strike that seems more and more likely by the day.

Sadly, I do not see the current Iranian regime reacting rationally to such a strike and thus do I lean more towards the latter two possibilities I lay out above.  My advice, better to be long and wrong, for a while, then wake up short when the balloon goes up.  Demand for crude oil is not going away any time soon regardless…access to supplies, however, may soon be another matter entirely.

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