Middle East Risks and the Oil Market

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This transcript is from a CSIS podcast published on April 10, 2024. Listen to the podcast here.

Jon Alterman: The Iranians are always a bit of a wild card when it comes to regional affairs. But the Iranians like unpredictability, oil markets don't like unpredictability.

Ben Cahill: Thanks for joining us on the Energy 360 Podcast. I'm Ben Cahill, senior fellow in the Energy Security and Climate Change Program at CSIS. On April 4th, brent crude oil prices rose above $90 a barrel for the first time since October, and there's suddenly a lot of speculation about a hundred-dollar oil. Geopolitical risk is a big part of the equation. Oil market fundamentals have shifted in recent months with strong oil demand in the first quarter, extended production cuts by OPEC+ through the middle of the year, and expectations that shale growth in the United States will finally slow. All this suggests a tighter market by midyear. OPEC still has a lot of spare capacity, but in this type of market, geopolitical risks start to resonate and that's what's happening now On April 1st, an Israeli airstrike on part of Iran's embassy compound in Syria killed seven senior military officers, and the expectation is that Iran will have to respond in some way. These tensions add to a fraught climate in the region with the terrible violence in Gaza still unfolding and Houthi attacks on Red Sea vessels disrupting global shipping. So, to talk about these events in the Middle East, I'm really happy to be joined by my colleague Dr. Jon Alderman. Jon is Senior Vice President and Brezinski Chair and Global Security and Geostrategy at CSIS. He's also the director of the Middle East Program. 

Jon, welcome to 360. Thanks for being with us.

Jon Alterman: It's good to be with you Ben.

Ben Cahill: So, lots to talk about, but I thought maybe we could first talk about the significance of this airstrike on that Iranian embassy compound in Syria. Just explain why that is significant and what happened.

Jon Alterman: Israeli jets seem to have had very good intelligence and very good capability to target a meeting of Islamic Revolutionary Guard Corps commanders who have been involved in Gaza. They seem to have waited until diplomatic personnel had left what was described as a consular building, so only military officers were killed. That suggests pretty good intelligence, thick capacity to, of course, penetrate Syrian air defenses. To destroy a target like that suggests the Israelis have pretty good capability. The Iranians I think are going to feel a need to respond. Not so much to dissuade these Israelis, but to encourage their allies to say, we have your back. We're not just going to take this lying down. I think from the perspective of a country that has been building up what they describe as an axis of resistance in the Middle East, you can't take a hit like that and not react.

But I think at the same time, the Iranians are very cautious about getting into an escalatory spiral with Israel that they think they might lose. The Iranians have been investing billions and billions of dollars in Hezbollah in Lebanon. They have been investing in Iraq and elsewhere in the region. The challenge of Lebanon for both the Iranians and the Israelis is that an escalation in Lebanon could get very violent for both sides cause a lot of destruction. Hezbollah and Lebanon have probably about 150,000 rockets and missiles. They can cover all of Israel. Israel could flatten all of Southern Lebanon, which is the base for Hezbollah, which as I said, Iran has put billions of dollars into over many years. My sense is that neither one wants to have the big war. Now Israel feels it might need to demonstrate a willingness to do that. Hezbollah may feel a willingness to show that it's not defenseless. You could miscalculate your way into war. It doesn't feel to me like either side wants the calculate its way into war, but there is that very real possibility and there's been more violence over the Israeli Lebanese border in the last week than there's been quite some time.

Ben Cahill: And I think we also have seen in the past that Iran doesn't necessarily lash out and respond right away when events like this happen. It's got lots of assets that its disposal, that it can sort of work overtime and also limited capabilities.

Jon Alterman: Over time and also limited capabilities. I mean, it's a combination of it has lots of options. It doesn't have any great options. It certainly doesn't have as many options as the Israelis do. So, it's partly when they think they'll have an opportunity when they think they can do something that won't provoke an escalation with Israel. The Iranians love to do what a former CIA operative once described to me as attributable, but deniable operations, what Karim Sadjadpour at the Carnegie Endowment calls implausible deniability. I think the Iranians want something that has some fingerprints but doesn't get them into a rapid escalation because they don't really have many options when it comes to a rapid escalation. Certainly, they don't have as many direct and punishing options as either Israel or the United States.

Ben Cahill: So, in some ways it's about putting a weak hand well and again.

Jon Alterman: Again, and they played a weak hand well. I mean if you think about it, President Raisi came in in August 2021. He said, we're not going to keep chasing the United States and its allies. We're going to build closer ties to China and the rest of Asia. We will improve our regional ties. We will build this axis of resistance. And I would argue that from an Iranian perspective, that's gone very well. They have shifted the momentum. They have not only built ties with China, but they've very much strengthened their ties with Russia. They have protection security council. They are seeing increasing hostility to the United States presence in the Middle East. Israel is more isolated. Israel's efforts at regional integration are halted if not reversed from an Iranian perspective. If you assume that there's no good story out there and you're going to have to be fighting for your survival and there's going to be tension and conflict. I think the Iranian analysis is we have done quite well. We have our instruments of deterrence, and we are in a better position to bargain now than we were a year ago, and that's all they want.

Ben Cahill: Yeah, that's really interesting. You mentioned, I want to get into some details, maybe about some potential actions or retaliation. So, you mentioned Hezbollah's rocket arsenal in Southern Lebanon. We've also seen in the past that with plausible deniability there could be attacks on tankers and sabotage. There could be strikes against U.S. assets or even troops and places like Iraq and Syria. Can you talk a little bit in more detail about what else might fit the Iranian calculus here and what we might expect if we are trapped in sort of a bit of an escalatory spiral here?

Jon Alterman: So, as you say, the Iranians are deeply into Iraq and Syria where you have U.S. troops, they have a window into Israel, which is one of the principle reasons they built up Hezbollah in the first place. There are all sorts of soft targets around the world. Israeli targets, Jewish targets that you can imagine the Iranians might seek to attack. I think they would be reluctant to go after an American target just because the U.S. has the ability to project for so effectively into the Gulf in a way that Israel really doesn't. It's a little bit far away for Israeli jets to reach. It's not far away because the U.S. both have bases in the region and has aircraft carriers to run things off of. So, I think the Iranians are unlikely to attack the United States. Of course, the United States put out a statement right after the attack in Damascus saying, we didn't know about it in advance.

We didn't approve it. This isn't us. So, I don't think you're going to see the Iranians doing something bold against the United States. There will be something to signal to the Israelis, but as I said to their allies especially, we're not just going to take this long down, but given that everything is from an Iranian perspective, given that everything is moving their way, I don't think this is the time they want to risk a reversal. This is a time when they want to mark up a draw, say we've responded and continue to win the larger game that from an Iranian perspective, they're continuing to win.

Ben Cahill: So, along those lines, I know you have a new essay out in Foreign Affairs. It's called A Détente Option for Iran, and as I understand that's about Iranian behavior in the region and maybe some misperceptions about what the U.S. should do in response of what's effective. So just talk to us about what that essay is about. 

Jon Alterman: There's an assumption in the United States that if the U.S. just applied enough pressure to the Iranians that the Iranians would behave. And it's a combination of U.S. effort and signaling the U.S. willingness to exert force that you reach a tipping point, and the Iranians will be on good behavior. People often talk about that as a way to deter Iran. I don't think that's the way it works. I think the Iranians, first of all, that's not the way deterrence works, but the Iranians are not, it's not a question of getting the Iranians to continue not to do things, which is what deterrence is. It's a way to get the Iranians to be more selective in what they do. And the Iranians continue to act across a very wide variety of fronts using a very wide variety of instruments. They're constantly testing, exploring, probing. What I argue is that we have to first be a little clearer about what we actually care about because you can't control all of this Iranian behavior offensive as we find a lot of it to be.

Second, we should be a little less predictable. Don't let them probe and figure out where the red lines are. Let them worry about where the red lines are. A little more uncertainty I think would inhibit Iranian action. The third part, which may be counterintuitive, but the Iranians have to believe that better behavior will result in better circumstances for them. And if they think that the United States is only going to be turning the screws, turning the screws, turning the screws a one-way ratchet as people sometimes describe it, then there's no actual cost to bad behavior because you get the results regardless. And I think that a degree of assurance, not that you can solve the tensions with Iran because I think it's going to be a very long time until we can resolve U.S. tensions with Iran, but some Iranian sense that there's a relationship between how they act and how the United States acts toward Iran would actually encourage better behavior as long as we accept it's not going to be very good behavior for quite some time.

Ben Cahill: And that perspective is important this year. I think because it's an election year, there's obviously a lot of concerns about events in the Middle East. There are concerns about the energy markets and the oil price. There are some broad incentives for the United States to maybe engage a little bit, create some understanding of what more constructive understanding would be and some of the rewards for stopping some of these provocations and instead changing behavior. A bit like some signaling from Washington could help in that regard I imagine.

Jon Alterman: But of course, there's no political constituency in the United States for loosening pressure on Iran. From an Iranian government perspective, Rouhani tried to improve bilateral relations and ended up with the Trump administration's maximum from pressure campaign. That being said, I've spoken to some Iranian academics who get very enthusiastic about the possibility that a new Trump administration would feature a president who is attracted by the idea of negotiating face-to-face. And this could potentially provide an option whether we get to a Trump administration, whether we get to a negotiation, I don't know. But I think it's important to note that the Iranians don't seem to me to be especially scared of return to the Trump administration. And you could argue that from an Iranian perspective, the most important thing is not to have a world united against Iran. And you could argue that a Trump administration almost guarantees the world won't be united against Iran. And you could say that advances Iran's interest. Again, I think the important baseline is the Iranians don't assume that everybody's going to get along. If your premise is you're going to have to fight for your survival and fight against isolation and use all sorts of asymmetrical tools against stronger powers just for survival, if that's your baseline, that gives you a very different pattern of behavior than what the United States is constantly striving for, which is can't we all just get along and deploy our troops to where it really matters in East Asia and move on.

Ben Cahill: And you've already talked about the Iranian relationship with China and Russia in that regard, which is important. The other thing you note in the article, which I also think is important is sanctions are dere for Iran right now. They've become accustomed to it. They've built up this resistance economy. And so, from a political economy perspective, they've adapted. Right? And there are a lot of reasons for the leadership in Iran to actually shrug all these things off and say, look, we've adjusted. The United States is doing everything we can. It's throwing everything at us, and we've resisted all this economic pressure, and we still have friends and options, right?

Jon Alterman: Partly because they run the smuggling networks that circumvent the sanctions and they make a lot of money through that, partly because it gives them an excuse for their economic performance. They say, well, it's under sanctions. This is because we're fighting a war with the United States. I think one thing that Americans consistently get wrong is we assume that when we put the screws to an authoritarian government that the people will be on our side. I think we misunderstand in many cases; even bad governments can play a nationalist card much more effectively than a foreign power like the United States. People rally around their own besieged, ineffective bad government rather than rally around a foreign power that's trying to displace their bad government. We don't quite get that. I think we still have this image, and we saw it in the Iraq war in 2003 that we assumed that the Iraqis would be welcoming us with flowers and candy after a horribly repressive regime and anti-Americanism in Iraq quickly became very much a thing. And I think we sort of assume that people see our positive intentions, but even bad governments are often very effective at undermining that.

Ben Cahill: So let's broaden the aperture a little bit. I want to talk about how events in the region have unfolded since October. I wonder if you could just talk about the mood in the region since the Gaza War, and I'm especially interested in how it's changed some of these shifts that we've seen in recent years, right? We had a United States trying to disengage from Middle East Wars, we had the Abraham Accords. We've had some interesting, I wouldn't say reconciliation, but more of a normalization between Iran and Saudi Arabia and Iran and the UAE. The Gaza War seems to have scrambled a lot of these things and across the region there seems to be an incredible resentment towards the deaths that we're seeing in Gaza, a huge amount of anger towards Israel and the United States. It's a very fraught climate. So these latest events are part of it, but things have been brewing for some time. It's a macro question, but can you just give people a sense of how the events of the past six months have really shaken things up and how this latest kind of series of events between Israel and Iran add to that?

Jon Alterman: What I keep hearing from people is an incredulity that the United States talks about international law. The United States talks about the in viability of borders. The United States talks about a global order and in the view of people in the region partly who are watching Al Jazeera, partly who are following social media, they say Israel is violating all of those principles, not only with impunity from the United States, but with support from the United States. They think that for a United States that talks about the rule of law and global order, it's absolutely inexplicable that the United States should turn a complete blind eye while with a straight face and at the same time encouraging the world to align against Russia and support Ukraine. And from a regional perspective, when you combine this with a sense that the United States was interested in pulling up stakes in the region and abandoning the region to Iranian depredations and focusing instead on the Western Pacific, it's a region where the population says, we don't have a future with the United States.

Why would we want a future with the United States? And governments are different. Governments feel that the United States has an enduring role, and I think people often overlook the fact that all the diplomacy about the resolution of the war and Gaza centers around the United States, Russia is completely absent. China is completely absent. The diplomacy is U.S. led diplomacy, and you couldn't like it or not like it, or you can say it's effective or not effective. But the fact is all the serious talks about getting a ceasefire and getting hostages released from Gaza, have the CIA director Bill Burns in the middle of them, you have Secretary of State, Tony Blinken repeatedly going out to the region. It's what President Biden says that matters with the Israelis. So it seems to me that from a governmental level, there's some frustration but also a recognition of the fact that there is no power or collection of powers that can do what the United States can do.

There's deep frustration. The U.S. isn't doing more. There's deep frustration. The U.S. is enacting differently, but the United States has a future in the region that I think governments recognize on a popular level, approval of the United States is in the low single digits. Somebody told me in Jordan, it's polling around 1% approval. I think that's within the margin of error. And if you look at some of the images and some of the discussion about it, you start to understand why it's there. I think the other interesting piece is that the humanitarian part of Gaza is entirely absent from the Israeli narrative. If you look at the Hebrew language press, not the international Israeli press, but the Hebrew language press, there's almost nothing about the humanitarian situation in Gaza. If you look at polling of Arab opinion, Palestinian opinion, nine out of 10 Palestinians don't think that the Hamas committed atrocities on October 7th, and you still have 70% or more of Palestinians who argue that arm struggle has to be the way forward.

So you can look at public opinion in lots of ways, and I think almost all the findings will make you depressed. We have a long way to go, but in terms of the mood in the region, the mood in the region is bad. The other sort of asterisk to that is that there's some frustration in the Gulf that they are doing economic diversification. They're doing all sorts of interesting and important things regarding the energy transition, as you know, and nobody's paying attention because everybody's attention is sucked up by Gaza. And there's a certain degree of frustration that first the Saudis were hosting the G20, but it got hit by Covid and had to be remote, and now they're doing all these other things after COP in the UAE and elsewhere and everybody's absorbed with Gaza and they say, well, when are people going to pay attention to our very important economic transition issues? Again, I think that's sort of a government concern, but the popular mood is just absolutely poisonous and absolutely poisonous toward the United States, which they say talks about values and then given an opportunity to apply those values has absolutely no interest in lifting a finger.

Ben Cahill: Yeah, I'm glad you've discussed all this. I do think that a lot of people in Washington don't understand how much perceptions of the United States have been harmed, deeply harmed by the events of the last couple months. And of course, this is part of a longer trend in concerns about us relative disengagement from the region, but it's really significant that it's changed so dramatically in the last couple months. So, to bring this back to energy markets to close out, I mean the oil market, despite all the events in the region, it's been fairly subdued since October. The impact, I think the market has shrugged off this risk of an escalatory spiral in a wider regional ward, withdrawn on Hezbollah and other factors. Something about the market response to geopolitical risks seems to have changed. The market just doesn't respond to these things the way that it used to.

I've been puzzling through why that is the rise of quantitative trading in the market, just like a generational shift and among traders, I think a lot of it has to do with satellite data and surveillance and knowing almost in real time what is actually happening and shrugging off supply risks until they materialize. But the market has shifted a little bit, but now traders and policymakers are really wondering about how well they can predict what's going to happen next and how much this conflict might spread. So, I guess my final question for you is how can governments in the region contain this? And you've written in the past about governments getting together to solve their problems. Of course, the U.S. is still kind of an indispensable factor in the region as you discussed here, but there was a sense that the region was trying to come together and contain this conflict and prevent it from spreading and getting worse. Is there something to be optimistic about in terms of not letting this get out of control?

Jon Alterman: I think governments don't want it to get out of control. The Iranians are always a bit of a wild card when it comes to regional affairs. I think the Houthi attacks on Red Sea shipping, which I don't think the Iranians control, but I think they often cheer quietly. They seem to have a surveillance ship that's in the Gulf of Aiden. It's helping things along. But the Iranians like unpredictability, oil markets don't like unpredictability. I have never thought there's a high likelihood of a real explosion. There's a sustained possibility of a real explosion, but I don't think there's a high likelihood of it. And there are two ways to get into a war. One is you escalate intentionally, and the other is you escalate unintentionally. Israelis are convinced that they need to respond disproportionately in order to deter their adversaries. That could get you into an escalatory spiral pretty quickly.

But again, I think nobody wants to go there. I don't think there are a lot of tools that Iran has through proxies, through drones, through other kinds of things. I think the Israelis probably are pretty happy with what they were able to pull off and might be willing to accept an Iranian response that they think is not consequential. I think the Iranians are mostly wanting to signal to their own people and don't need to signal to the Israelis. So, I could see a way for us to get to an off ramp just the way after Iranian proxies attacked the U.S. based Tower 22 in Northern Jordan. After U.S. response to that, the Iranians didn't attack any U.S. and their proxies didn't attack U.S. forces for more than a month. So, I think one of the challenges we have thinking about the region is one of our premises is everybody who is hostile to us must be irrational because when you're looking at the United States, what's not to love, and I think that we have in the Middle East a lot of rational hostile actors.

I think they're interested in probing; they're interested in exploring, despite the fact they talk about martyrdom seeking operations. They're not really interested in martyrdom. And my guess would be that there's a much better than even chance that we're able to navigate our way out of this. That being said, you have to worry about low probability, high impact events, and the Middle East for many months to come is going to give us the possibility of low probability, high impact events, the Israeli assault on the convoy containing World Central Kitchen workers, I think is an example that one night's events can change everything. I think you're starting to see it in the U.S. attitude toward support for the government of Israel in this war. I could imagine we wake up one morning and we're in a different place, not likely, but the longer this goes on, the longer their attentions, the more likely cumulatively it is that we get into that position.

Ben Cahill: Well, the mood is definitely shifting in the region. The mood is shifting in the oil market. So Jon, I'm really grateful that you could join us today and help us make sense of these events. I encourage everyone to read Jon's piece in Foreign Affairs. We will add a link in our show notes. So Jon, thank you for joining us and thanks to everyone for listening.

Jon Alterman: Thank you, Ben.