Pompeo, the Iran Deal, and the Asymmetric Proxy War

U.S. Secretary of State nominee Mike Pompeo said yesterday at his Senate confirmation hearings that he would actively try to “fix” the Iran deal, working with U.S. allies to “achieve a better outcome and a better deal.” The oil market didn’t appear to believe he would succeed. While Pompeo was laying out his views, Brent prices topped $72 a barrel amid reports that there had been an unsuccessful drone strike on Saudi Aramco’s Jizan refinery in southwest Saudi Arabia. The foiled drone attack by Yemeni Houthi rebels was unnerving for two oil-related reasons. Firstly, it was yet another indication that the proxy war between Saudi Arabia and Iran in the region was both escalating and continuing to target oil related facilities. Secondly, and perhaps even more disturbingly, it was a sign that “asymmetric warfare” posed a greater threat to oil than could have been previously understood. Increasingly, there has been evidence that sub-national groups can build make-shift drones that can deliver payloads into hard to reach targets. The Jizan refinery attack was the first time a makeshift drone attack has been widely reported to have targeted an oil facility. The drone onslaught follows a serious cyber breach that has plagued a commercial safety system used in oil refineries. Both means of warfare pose serious risks not only to the Saudi oil industry but to Western and other regional facilities as well, upping the ante on a host of conflicts that involve Iran. 

The United States is due in May to decide whether to take steps that would effectively re-impose oil sanctions against Iran. During his visit to Washington, Saudi Crown Prince Mohammed bin Salman lobbied the Trump administration to reopen the Iranian nuclear deal and pressure Iran for better terms that would ensure Iran never obtains nuclear weapons, rather than the publicly announced terms which reduces the number of Iran’s centrifuges and limits the level of uranium enrichment to 3.67 percent, far below weapons grade, for fifteen years. Under the nuclear deal, Iran is tasked to remove the core of its heavy-water reactor at Arak, capable of producing spent fuel that can yield plutonium. 

Last month, European leaders were sounding out the possibility that fresh sanctions be imposed on Iran aimed to moderate the country’s ballistic missile program and its role in regional conflicts in a manner they hope would maintain the Iran nuclear deal. Saudi Arabia is likely to oppose that approach. The Saudi diplomatic message regarding the Iran deal could put the kingdom under pressure to offer to replace Iranian oil that would be lost to buyers, should a re-imposition of oil sanctions against Iran become necessary. Saudi Arabia has failed to act to replace declining Venezuelan oil production, as it could have done in past decades, preferring rather to replenish depleting financial resources by tapping higher oil prices. That has led to divisions within the Organization of Petroleum Exporting Countries (OPEC) on what could constitute too high an oil price that would begin to harm oil demand. 

Rather than talk publicly about replacing any “sanctioned” barrels, Saudi Arabia has been pushing a plan to have “decadal” cooperation with Russia regarding oil prices. Saudi leaders would like to structure a long lasting agreement that could eliminate the debilitating cyclical swings in oil prices. But it remains unclear how that would be accomplished, short of coordinating investment rates for most of global oil production capital spending, as was tried (also relatively unsuccessfully) by the Seven Sister oil companies back in the post-World War II era. One alternative suggestion, said to be a non-starter among fellow OPEC members, would be to return to the fixed oil price system of the 1970s. That system was undermined when OPEC members were forced to cheat behind each other’s backs using non-transparent, complex price discounting schemes such as barter deals, secretive tanker freight discounts, and extended credit terms to ensure their oil wasn’t replaced by sales by producers offering spot market related pricing. 

The appointment of more hawkish foreign policy members to the Trump administration's national security team has already affected Tehran, which has had increased difficulty marketing its oil in recent weeks and is now offering additional discounts to sway buyers who are worried about the effects of future sanctions policy. European companies are considering contingency plans, and Japan reportedly curtailed its oil imports from Iran in March. Some loss of Iranian volume is probably built in to current price levels, but the geopolitical ramifications of escalating conflicts could create more uncertainty in oil markets. 

At this particular juncture, from the U.S. point of view, the oil aspect of Iranian sanctions policy could be more tangential compared to concerns about Iran’s role in the various Mideast regional conflicts. The United States has tried to counsel Saudi Arabia to find a way to deescalate the conflict in Yemen but so far, little progress has been made. The United States also would like to fashion a Syria strategy that limits Iran’s role in the Levant. One lever in that process is that neither Russia, Turkey, or Iran are in a financial position to pay for Syria’s reconstruction, creating a possible starting point to assert influence by the United States and its allies. Commentator Hassan al-Hassan argues that now is the ideal time for the United States to make a strong response to test whether the current facts on the ground render President Bashar al-Assad as suddenly more dispensable to his own supporters. He suggests whatever actions the United States takes be designed to force parties to abandon the military option. U.S. sanctions moves that recently cratered $12 billion in the wealth of Kremlin insiders and hampered their ability to work with large commodity traders were a step in the right direction.