More of the same tension and temporary asset price moves, not full-blown war
Any spikes in oil price (i.e. concerns on supply risks from GCC exporters), or sell-off in those regional (MENA) assets that are otherwise attractive (e.g. Dubai, Lebanon, Oman and Saudi equities), during bouts of escalation in tensions between the US and Iran should be viewed as temporary. The deployment of additional forces and the reported sabotage of commercial vessels off the coast of the UAE prompt us to lay out the reasons for this central case (and consider the counter case).
Since the start of the Trump administration US-Iran relations have deteriorated; closer relations with Saudi, reneging on the Iran nuclear deal, removing oil sanction waivers, designation of Iran’s Islamic Revolutionary Guards as a terrorist organisation, and deployment of additional air-strike-capable US forces to respond to potential Iranian threats.
But the path to a full-blown war is not inevitable, contrary to rhetoric from parts of the Trump administration and portrayal as such in sections of the mainstream media. For both sides, the conduct of a full-blown war is too difficult, uncertain and damaging. This is not (yet) a case of nuclear MAD (mutual assured destruction) as in the case of the US-North Korea or India-Pakistan but it comes pretty close. Nevertheless, continuing tensions are highly likely because the US has the tools to continue applying diplomatic and economic pressure and Iran has the economic resilience and a sufficiently authoritarian political system to withstand that pressure (however painful for socio-economic development).
The arguments underpinning our view are as follows:
(1) While the public face of US foreign policy personnel is dominated by long-standing hawks (Bolton, Pompeo), the mass political support for committing large numbers of US troops to another ground war has waned following the Iraq and Afghan deployments and the draw-down of troops currently underway in those arena (as well as in Syria).
(2) The strategic importance of the Middle East region is vastly reduced from a US perspective given that (a) its historic hot military conflict intervention in Iraq has not resulted in the sort of client state it might have initially hoped for (and its intervention has indirectly contributed to a stronger regional position for Iran) and (b) the growth of US oil and gas production has made controlling Middle East oil output and transit choke points much less critical than in previous decades.
(3) The siege of the Iranian economy (US sanctions which have contributed to an FX rate collapse, oil export collapse, halt to foreign investment, and growth slowdown) is likely the best guarantor of a change in Iranian foreign policy (and, potentially, its current domestic political system) but this can be achieved via persistence with sanctions, rather than a full-blown war.
(4) The increasingly public alignment of Israel and Saudi may be sufficient to establish a regional balance of power with Iran without a full-blown war (certainly, Israel appears to have attacked Iranian assets in Syria without significant direct response by Iran, its proxies or international allies).
(5) The EU (which prefers resurrecting the nuclear deal) and Turkey (which has an overlapping interest with Iran to curb Kurdish ambition) would be unlikely to join a US military coalition. Both the EU and Turkey also have an interest, in the long-term, in developing Iranian gas imports as an alternative to Russia, Algeria and Qatar.
(6) The GCC is publicly divided and Qatar (which shares its main gas field with Iran) would be an unwilling part of a coalition (its hand may be forced because it houses the US regional air force but its conflict of interest may jeopardise the long-term viability of that base).
(7) The regional repercussions of a full-blown war with Iran would be far greater than that seen in the Iraq or Yemen wars because of Iran's long-cultivated regional allies (in Bahrain, Gaza, Iraq, Lebanon, Sudan, Syria, Yemen), some of which are in government and some of which are not.
(8) The mountainous terrain surrounding Tehran makes it a formidable location to attack and occupy.
(9) The escalation to a full-blown war may terminally undermine the “pragmatic conservative” camp in Iran (e.g. the likes of President Rouhani and Foreign Minister Zarif, under whose watch the nuclear deal was negotiated, would be punished for achieving no lasting security or economic gains despite committing to a moratorium on nuclear weapons development) and shift power even more decisively to the Iranian Revolutionary Guard and the “principilist conservative” camp. This is a potent issue given the looming succession to 80-year old Supreme Leader Khamenei.
(10) Russia and China would likely be drawn, at least indirectly, to support Iran in the event of a full-blown conflict (in order to increase the costs of the conflict for the US, and avoid a precedent of regime change for a non-aligned US state).
The counter-case: rational or irrational irrationality
The main risk to our thesis, i.e. what could make this time different, is if the US should no longer be viewed as a rational, or at least, conventional actor; i.e. it is more willing to engage in military brinkmanship and adventurism. Certainly, if the US administration can successfully shape the anti-Iran narrative domestically, particularly with the next Presidential election in November 2020, then this non-conventional approach likely persists. There is survey evidence, illustrated below, to show that (1) the US general public’s view of the threat posed by specific countries is quite volatile (malleable) and (2) among Republican supporters currently, Iran is viewed as a greater threat than Russia, China, or North Korea.
Usually in balanced conflicts, where one adversary is, in conventional terms, much stronger than the other, it is usually a dominant strategy of the weaker protagonist to portray maximum unpredictability, unconventional tactics and irrationality. The weaker adversary portrays the willingness to take more extreme action because it has less to lose from disrupting the status quo. On the other hand, the stronger protagonist has more to lose from disrupting the status quo and therefore acts in a more restrained manner. The historic behaviour of Iran (particularly under Ahmadinejad), Iraq (under Saddam), Libya (under Qaddafi) or North Korea (particularly under Kim Jong Un), in terms of their respective conflict with the US, supports this theory.
Arguably, this theory has been flipped around in the current phase of the US-Iran conflict: Presidential tweeting undermines State Department-led diplomacy, reneging on the nuclear sanctions deal compromises US credibility in future negotiations and makes for frostier relations with the EU, and threatens a war which is likely uncontrollable and un-winnable.
Whether the approach of the Trump administration is the result of a loss of faith in the conventional approach (i.e. that approach has failed, the nuclear deal was insufficient in scope, and therefore to achieve a better deal quickly there is rationality in portraying irrationality), the capture of US foreign policy by much narrower interest groups than historically (e.g. an increasingly right-wing and authoritarian Israeli government) or a result of genuine incompetence and irrationality is, ultimately, a moot point.
US perception of foreign policy threats
Source: Gallup (2019)
US public perception of foreign policy threat on a partisan basis
Limiting the power of which country should be a top foreign policy priority (%, Nov 2018)
Source: Pew (2018)