The biggest risk of higher oil prices looks to be the latest storm brewing in the Middle East. Our contention has been that oil prices are destined to slip back to their pre-stock-bounce range once economic reality sets in and demand remains persistently low. To that end, we own a hedge against falling oil prices.
However, the likelihood of military action against Iran by either the US, Israel, or both is growing, and such action would cause oil prices to spike. Let's look at the situation and chance of an attack, and why it would put upward pressure on oil prices.
In April, the Obama administration granted Iran until Sept. 24 to open talks with the five members of the UN Security Council plus Germany, a group referred to as P-5+1. The consequence of not doing so was to be harsh sanctions. Since then, Obama extended a fig leaf to the Islamic world with his friendly speech in Cairo, the appointments of special envoys George Mitchell for Israel/Palestine and Richard Holbrooke for Afghanistan/Pakistan, and soft-edged diplomacy intended to reverse harsh feelings left over from the Bush years.
The result of the fig leaf has been impressive when judged by the content of warm speeches all around, but not so great when judged by the list of concrete steps to improve upon America's interests in the region. Terrorist activity has not declined, Mitchell was unable to change the situation between Israel and the Palestinians on the settlement issue, Holbrooke hasn't improved the Afghanistan War situation at all, and, most vital to our discussion, Iran hasn't budged in its nuclear ambitions or even attitude toward the US and the P-5+1. It's now past the Sept. 24 deadline, and the situation technically calls for sanctions to be applied. Will they be?
Apparently not right away, because the talks have been rescheduled to start this Thursday, October 1. Few are holding their breath for the talks to mean anything, anyway, so attention is already turning to what will happen when Iran changes nothing.
If the sanctions are applied, they need the cooperation of China and Russia in order to work. Either country could supply Iran with all the fuel it needs, and both countries have expressed their disapproval of the sanctions. So, the sanctions are looking like a joke.
That leaves an attack as the most probable way of thwarting Iran's nuclear plans. It would likely involve both the US and Israel, because either country's initial entry into a fight with Iran would draw the other in. Israel can't go it alone against Iran and the US won't let Israel come out of a conflict worse off.
Besides, the first thing Iran would do in case of being attacked is close the Strait of Hormuz, which would bring the US immediately into the fight.
