In the summer of 1507, after the conquest of Socotra, the Armada’s main objective, Afonso de Albuquerque departed on his own, commanding a fleet of six vessels and 500 marines to take the easternmost island at the entrance of the Persian Gulf, called by local folk Hormuz. Defeating a garrison of 15,000 men with his artillery, Albuquerque took Hormuz and commissioned the construction of a fortress.
This island would eventually lend its name to one of the most important choke-points of the Indian Ocean, at the time the principal commercial pathway of commodities from Asia to Europe. Afonso de Albuquerque had brought with him from Lisbon a sealed letter appointing him as Vice-King to the East Indies, replacing Francisco de Almeida, whose strict naval prowess policy didn’t impress the territory-hungry King. A period of indecision ensued, with most naval officers in the region initially refusing Albuquerque’s rule and Hormuz was lost. In 1515, in his final days as Vice-King, Afonso de Albuquerque stormed Hormuz once again, taking it for good without military resistance.
The fortress that stands to this day was finally completed, sealing the command over the commerce in the region. Beyond fortresses, the Portuguese left another lasting mark of their presence in Persia, which is the name of the currency, the rial.
After the Portuguese came the Persians, and then the English. The importance of the fortress waned, but that of the Strait of Hormuz itself, if anything, has only increased. Commodities flow in the opposite way these days, but unlike the luxury and exoticism of the past, today they are vital inputs to the world economy.
About a month ago, when Iranian officials started venting the idea of closing the Strait of Hormuz to commercial traffic, Western media was prompt in reviewing the events of 1981. At that time, Iranian forces mined the Strait and engaged commercial vessels with rubber speedboats in what was largely seen as a pathetic attempt to control the area. The media seems to think that Iranian officials are talking about using similar tactics today. In reality, the military technology deployed by Iran in the region is completely different today, creating a strategic scenario totally different from that of 30 years ago.
According to the EIA, 17 million barrels of petroleum crossed the Strait of Hormuz each day during 2011. This makes up almost 40% of the international petroleum market, clearly the most important choke-point of the world for this commodity; on average 28 oil tankers cross the Strait every day, half of them empty and inbound, the other half outbound. Adding to petroleum is liquified natural gas (LNG), exported by Qatar and the UAE ; over 6 million tones of LNG cross the Strait every month, about 25% of the international market. All of this traffic takes place very close to Iranian waters and shores.
Iran is a very large country, with an area of almost 1,700,000 km2, more than Spain, France, Italy, and Germany combined. To its south, Iran has a coast almost 1700 km long, which makes up all the north shores of the Persian Gulf (hence the name) and the Gulf of Oman.
Along this coast lie numerous islands of assorted sizes, including Levan, Hendorabi, Kish, Forur, Sirri, Abu Masa, the Tunb twins, Qeshm, Hengrn, Lark, and of course, Hormuz. All these islands are found west of the Strait, Hormuz being effectively the eastern most of them all. Qeshm is by far the largest of these islands, with 1490 km2, larger than all the other islands together. Contrary to what its name suggests, the narrowest section of the Strait is along the southeastern shores of Qeshm, between the smaller islands of Hengrn and Lark. Between Lark and the smaller isles of Oman, there are less than 40 km of water.
Sovereignty over the Strait waters is divided by Iran and Oman. The northern half is shallower and less suitable for large vessel navigation. Being deeper, the Omani half provides for the narrow naval corridors that make up what has been for centuries one of the world’s most important commercial routes.
The Strait of Hormuz. Source: Wikipaedia.
This post tries to portray the economic and military chessboard around the Strait of Hormuz today. In the first section, I try to gather the main characteristics of Iran’s economy and how it may be impacted by the sanctions being imposed today; a second section dives into the military technology Iran has to act upon the Strait; and in a third section I’ll draw several hypothetical strategic scenarios that may develop in the region.
Part I – Iran’s Economy
In this section I’ll look into Iran’s economy and try to understand the possible consequences of the sanctions imposed recently by the US, and to be followed shortly by the EU. This analysis doesn’t pretend to be in any way a thorough account of Iran’s socio-economic fabric, but simply a collection of points that are relevant in the present crisis. The data presented here were collected mostly from Wikipaedia and the World Factbook.
First of all, it is important to situate Iran in the world economic map. The country has a population of 78 million, and in 2010 its GDP increased to 400 G$. This puts Iran into the top 30 economies of the world, although in terms of GDP per capita, with a nominal figure of 6,250 $/cap/a, it is within the middle of world rank, on par with countries like Serbia and Belarus; though well ahead of China, for instance. Using purchasing power parity figures, Iran looks quite different; with some 12,000 PPP GDP/cap/a, it figures ahead of Brasil and not far from European states like Romania or Bulgaria. An important aspect about Iran is that unlike most of its oil exporting neighbours, it seems to have almost finished its population transition, with the growth rate slowly but steadily in decline since the 1980s; presently at 1.1 %/a.
Iran’s population growth rate. Source: Google.
Iran is a hybrid economy, with half of it spread over a diversified portfolio of private enterprises, and the other half subject to centralized planning. The country is presently in the middle of a very ambitious five-year plan ending in 2015. This plan aims at two large goals: to become self sufficient, and to shift the focus of exports from petroleum to industrial goods and gas.
This includes investment in ore mining and an increase of steel and cement production; the petrochemical industry should double in size and the rail network largely expand. The famous energy subsidies (more ahead) are to be completely phased out, in order to force a competitive hike of local industries. Iranian leaders have a big vision for their country: a modernized industrial economy that transforms abundant energy into value-added goods for export.
The analysis of Iran’s budget is quite difficult, given the contradictory data available. The World Factbook figures are 110 G$ for revenues (27% of GDP) and 90 G$ for expenses (22% of GDP); in Wikipaedia the revenue figure is put at 500 G$, which would come at 125% of GDP. Also from Wikipaedia, it can be learnt that revenues from oil exports stand at about 60 $/b, multiplying this by 2.2 Mb/d and 365 days it amounts to 50 G$ for the yearly oil revenue; a plausible figure that’s 45% of the budget revenue and 55% of expenses.
Gas itself doesn’t seem to contribute in any relevant way to the budget, though internal consumption is about 75% of production; what happens to the remaining 25%, I couldn’t determine. But the most intriguing aspect about Iran’s budget is the energy subsidies. Wikipaedia quotes a dead link to Iran Daily that claims that this figure was 84 G$ in 2008, including oil products, gas and electricity, implying that over 90% of expenses are used for this purpose (this could be referring to lost revenue instead, but even then it would be too high).
Looking at the trade balance, Iran runs an yearly surplus of 28 G$, about 7% of GDP. Exports in 2010 were worth around 84 G$, of which 80% was crude petroleum and 4% petrochemicals. The largest buyers of these goods were China (16%), India (13%), and Japan (12%), in what seems to be a fairly wide portfolio of export partners. Imports in 2010 amounted to 59 G$, of which about half were industrial raw materials and a third capital goods. The largest sources of these goods by a good margin were the UAE and China, with 15% each; again, the portfolio of import partners is quite wide, with certain European states showing some relevance, especially Germany (10%) and Italy (5%).
Beyond the countries mentioned, Iran also has important commercial relations with South Korea, both on imports and exports. A contradictory account was given days ago by the Tehran Times, claiming that the non-oil trade balance will be at zero next year. This latter claim would imply an expansion of non-oil exports close to 70 G$, from 17 G$ in 2010.
Although Wikipaedia presents a round figure of 100 G$ for the total foreign currency reserves held by Iran, the World Factbook presents a relatively lower figure – 75 G$ at the end of 2010, and a declining trend from over 80 G$ in 2008. This is one of the important points where the information available is diverse, though the declining trend helps explaining the rapid devaluation of the rial since last summer.
As stated above, Iran consumes most of the gas it produces, primarily to generate electricity in relatively inefficient thermal plants. The 2010 – 2015 economic plan obviously intends to change this with the development of a nuclear park, freeing this gas for export. Adding to this is a rapid expansion of production in the South Pars field, by which Iran intends to multiply by five its oil and gas revenues, to 250 G$/year in 2015. Undoubtedly an ambitious figure, especially considering that sovereignty over parts of this mammoth field is still in dispute, especially in the border with Kuwait.
In another important sector, that of agriculture, Iran appears quite healthy. Long term programming since the 1979 revolution has slowly fostered an increase in the country’s food output, underpinned by a shift from subsistence to industrial agriculture and the construction of dams that widened the irrigated area. Today Iran produces about 90% of the foodstuff it consumes and has recently become a net exporter of wheat. It imports mostly rice, and since its exports (fruits, nuts, animal hides, spices) are more valuable, it could even be running an agricultural trade surplus, though I haven’t found hard data to confirm this.
As a final relevant characteristic, I’d like to point to Iran’s parallel economy, which accounts for 30% of the foreign trade, according to Wikipaedia. This implies huge revenues missed every year by the government, but more than that, points to corruption mechanisms deeply installed in state institutions. At this distance, and without hard data, I’ll avoid diving further into this subject, though this may have an important impact on the final outcome of Iran’s present economic plan.
Up to this point the most visible consequence of the tensions with NATO around the nuclear programme has been the devaluation of the national currency, the rial. The currency underwent a steady decline in 2011 that has accelerated since August; so far it has lost half of its value. Investors and common folk flocked to foreign currency and gold, even exchanging hard assets for liquidity. Between August and December, the Central Bank of Iran (CBI) alone sold 40 tons of gold.
In the weeks before Christmas, when the US Congress approved the new batch of sanctions, the CBI apparently lost the ability to supply US dollars, likely due to a stock rupture of greenback bills. A bank run ensued, and in the days before Christmas folk piled in to the CBI branches in Tehran to exchange their money for gold. In three days, five tons of gold were sold and the price of this metal at independent exchange offices clearly exceeded the values in international markets.
The Iranian government was very close to losing control during this time, something largely missed by the western media. I found this information well documented on a metals exchange forum, that in the meantime has mysteriously been removed from the public domain. The CBI stopped selling cash gold on 23 December, possibly due to a coin stock rupture, and now only offers four months futures contracts. Soon after, the government outlawed the exchange of rials for foreign currencies or gold.
The driver behind this devaluation of the rial is the perceived impact on the state’s budget, with a decline in revenues from oil exports. In fact, the amount of oil Iran presently exports to non aligned countries is not that large. A rough estimate points to 500 kb/d to China and India combined, while the remainder is relatively scattered. Especially if Korea and Japan join the US and the EU in these sanctions, it could become effectively impossible for Iran to export most of its surplus oil, even temporarily.
Government spending will certainly come under strain, affecting investments and likely the famous subsidies. Given the amount of foreign currency reserves it holds, Iran should in theory be able to sustain a de facto budget deficit for some time. But it is the vision of the erosion of the budget that is undermining the rial, as investors do not believe present leaders and/or institutions will be able to deal with this crisis and avoid the eventual exhaustion of foreign currency. Imports are also at stake, with scattered news reporting consequences for other sectors of the economy; as an example, Iranian airplanes have recently been having difficulties in getting refueled abroad.
Nevertheless, given Iran’s relative independence in certain sectors, daily life might not be subject to major constraints (i.e. empty shelves), provided the rial is brought under control.
In the longer term, these sanctions have another outcome: the impairment of the present economic plan. More than investment, the transformation of Iran into an industrial economy will certainly require the OECD markets to export the resulting products – in the first place, gas. The import of certain technologies and industrial goods only available from the West will also be affected, further impacting the modernization plan. Even if healthy commercial relations with other Asian nations survive, those are for the most part economies going through a similar process of industrial modernization, and in all likelihood will not be receptive to the same sort of products they export themselves. In essence Iran may endure but cannot permanently afford these sorts of sanctions, as they create a state in which Iranian institutions are forced to take serious measures.
Part II – Iran’s tactical options around the Strait of Hormuz
In this part I’ll go through several technologies that seem relevant in the military chessboard of the region; though somewhat long, this list isn’t exhaustive. I’ve no access to military intelligence, hence consider this a picture with many blanks to fill. Besides that, it is important to note that the weapons industry today uses many of the marketing tactics used by civilian industries, so the information they release to the public should never be taken as complete or totally accurate. And finally, many of the weapons here described were never used in combat (and I hope they never will), which only adds to the uncertainty of the information appearing in the public domain.
Luis has a long section on military hardware here. You can see it at the original post on The Oil Drum. -BA
Part III – Strategic Scenarios
Can an armed conflict erupt in the Strait of Hormuz? How can it come about? How wide can it develop? For how long can it disrupt commercial traffic? In this part, I formulate four different strategic scenarios that contemplate these questions, though not precisely answering them.
Scenario I – Direct engagement from Iran on commercial vessels at the Strait.
In this scenario Iran would employ one of its many seaborne weapons to either attack or block the way of oil tankers leaving the Persian Gulf. This could be done by torpedoing the vessel or targeting it with a small missile; alternatively, Iran could simply deploy some if its navy close to the commercial routes and emit a warning that every ship trying to cross the Strait would be sunk. The effect on oil prices would be immediate in the second case, even without firing a single a shot. It would be a sheer powerful defiance by Iran, aiming to guarantee that economic sanctions affect every major player in the region.
This would certainly force an intervention by NATO forces in the region, a scenario that could develop in two different ways. If NATO opts simply for defending navigation across the Strait, then the multitude of weapons Iran has would likely guarantee a long period of tension, with random attacks on both commercial and military vessels in the Strait. The economic consequences for the Asian importers would be dire and a worldwide recession would ensue. Otherwise, NATO could opt for a large scale operation to bring down Iran’s military capacities around the Strait. This would then resemble Scenarios II and III, whose outcome is not clear, especially in terms of the conflict time span.
I find this scenario the least likely of all. This would not only be an attack on oil importers, it would be above all be an attack on the major oil exporters around the Gulf. Iran has little interest in going at odds with its neighbours, especially in the case of the UAE, with whom it maintains a close economic relationship. Apart from the Emirates, Iran shares maritime oil and gas resources with Qatar, Saudi Arabia, and Kuwait, that are in some cases are already under joint development. And of course there is Iraq, with which Iran shares a long border that was the stage for a long and deadly conflict in the 1980s; certainly it is in no one’s interest to revive such tensions. A bold action like the one proposed in this scenario would require a totally desperate internal situation in Iran, and even so, Scenario II would be more plausible.
Scenario II – Direct engagement from Iran on military vessels in the Persian Gulf.
Instead of attacking or menacing commercial vessels, Iran could opt for an engagement on NATO’s naval forces in the Persian Gulf. The effect on oil prices would be about the same as in scenario I, but without the sense of a direct attack on Iran’s neighbours. This sort of engagement could come about as a consequence of some minor incident, such as a NATO vessel entering Iran’s waters or an Iranian aircraft or ship being hit. An incident like this can easily be faked if needed, but unfortunately, the growing tension and the bellicose discourse around the Strait can also provide for a real episode where at least one of the players feels compelled to larger actions.
Invariably this scenario would lead to a large scale conflict, not only in the Strait but extending at the very least to Iran’s long southern coastline. The outcome of such hypothetical conflict is elusive, but one thing is certain given Iran’s profuse weaponry and extensive territory, it can hardly be swift. Many uncertainties remain in surmising the correct power balance in the Persian Gulf at this moment. Is Iran’s wide range of anti-ship missiles and torpedoes capable of imposing damages on NATO’s fleet? Not only is the effectiveness of weapons like the Russian Moskit unknown, but the outcome of a wide simultaneous engagement with a multitude of anti-ship weapons on NATO’s vessels is also not clear. In the worst case, NATO’s fleet may be forced back to its naval bases in Bahrain and the UAE, and to operate solely from the Gulf of Oman. If something like this would ever happen, oil shipments across the Strait would be certainly affected for a long period of time, and the impact on the world economy would be devastating.
A second question is Iran’s capabilities in air defence. Can NATO project its air prowess as it did in the Balkans, Iraq, or Libya? NATO will certainly face a sort of opposition it never did before, both in the number and in the technology of anti-air missiles retained today by Iran. In addition to this, if Iran effectively possesses relevant numbers of modern-day jet fighters, then air dominance over Iran becomes completely uncertain. Nevertheless, NATO retains technology that Iran has no known counter measures against, especially state-of-the-art stealth aircraft built in the US. Hence it is certain that in case of such a large scale military conflict, NATO can continuously target military objectives in Iran, eventually eroding its operational capabilities. The question is how long such conflict can last to menace oil shipments across the Strait. Stabilization of the region could require a sort of military commitment NATO has never been forced into before. How could this play out with a ramping oil price conflated with the ongoing economic environment is hard to envision.
Though I find this scenario more plausible than scenario I, it still remains quite remote. Iran’s government still has other options to explore before finding itself in a desperate situation where military action becomes attractive.
Scenario III – Military engagement by NATO on Iran
In such a scenario, NATO would opt for a pre-emptive attack on Iran, targeting both Iran’s nuclear facilities and military assets around the Strait. This scenario has been spun both in Israel and the US, especially since Iran has threatened to close the Strait in retaliation against the hardening of economic sanctions. While it has been largely dismissed by the wider political spectrum, it should be noted that from a strict military perspective this is the conflict scenario that could be less costly for NATO members. Taking the initiative, it could guarantee the shortest disruption possible to the flow of oil through the Strait. Most of this oil (85%) feeds Asia; NATO members are already on course to phase out Iranian oil imports and the strategic oil reserves coordinated by the IEA would provide the means to accommodate the economic impact for some time.
The first problem with this strategy is if NATO is not able to promptly achieve air superiority over Iran, in such case not being able to tame the country’s menace to the oil flow in the Strait in a timely manner. As stated before, this largely depends on the numbers of modern aircraft and air defences Iran effectively possesses. If a relevant resistance to NATO’s air power is achieved, then a situation similar to the worst case of scenario II could develop.
Finally, in the event a wider military conflict develops between NATO and Iran, the much bigger question arises of how other military powers may react. In recent months, military officials from both China and Russia have made it clear they wouldn’t remain passive in the face of such conflict. This discourse may be an important deterrent to this scenario or any wider conflict in consequence of scenarios I or II.
With the information I could gather, it seems to me this option is risky (or at least uncertain) enough for NATO not to take it at this stage. It should remain a remote hypothesis, at least as long as real evidence of a military nuclear programme in Iran doesn’t come about. Finally, I should point out that considering Iran’s vast arsenal, a lone attack by Israel seems highly unlikely, at least with conventional weapons.
Scenario IV – No military action
At this stage, the most likely scenario is for no bellicose action to take place. This scenario has several requirements, but all achievable. In the first place the Iranian government has to stabilize its currency; so far this has been achieved by cracking down on the independent trade of foreign currency and gold, first by disabling the electronic means to do so and then by outlawing such activities. In this regard more will have to happen, as the government has to somehow re-establish public trust in the internal economic system. And then Iran must find ways to continue selling its oil, either by finding alternative importers, like Korea, that are not complying with US sanctions, or by “smuggling” oil to neighbouring countries that then sell it as their own. The fact that about 30% of Iran’s foreign trade takes place in the parallel economy can be an important start for this alternative trade. It is unclear what role the joint oil developments in the Persian Gulf may play, but they can provide a further workaround for Iran to maintain its oil revenues.
Iran’s economy will be undoubtedly impacted, but as seen in section I, it is rather self-sufficient, especially in agriculture. Some consumer goods may become difficult to get, as it is already happening with consumer electronics, but Iran should be able to provide the basic needs of its people in the short term, and once again seek alternative sources for its imports. It is unlikely that a Persian Spring will start to unfold. That the political system allows for public will to be expressed by voting and direct opposition to the theocratic structure has been a fable, squashed by fierce control of the media and internet. Thus, the political situation may remain relatively intact, facilitating a pure economic strategy from the crisis. If this scenario unfolds, it could simply result in a regionalization of Iran’s foreign trade, geographically constraining commercial exchanges to the Middle and Far East. Naturally China can play a major role in this process, and while some officials have been suggesting a compliance with the US line, it is in China’s interest to keep Iran somewhat inside its sphere of influence.
The only issue with this scenario is that it doesn’t guarantee to the US and NATO that Iran’s nuclear programme is halted. On the contrary, the technical advances of Iran’s nuclear technology keep on going, as recently announced by President Ahmadinejad. Though no evidence exists that this programme has military ambitions, those countries fearful of such a perspective, especially Israel, may get no reassurances at all from the increased sanctions. Will they rest quietly while Iran proceeds with the programme? This is why the previous three scenarios, though unlikely, are plausible.
The balance of interests around the Strait of Hormuz can be analysed from a Games Theory perspective. All players profit from the trade that passes in both senses through this choke-point, and any disruption has a negative impact on all of them; since they all stand to lose, no player changes strategy and the game remains in equilibrium. The sanctions imposed by the NATO members on Iran menace this equilibrium, as they can eventually translate into an effective disruption of the Strait, closing it to Iran for the large part. NATO has chosen this strategy because it now evaluates the equilibrium as having a negative impact: the hypothetical nuclear menace from Iran. In its turn, if the Iranian foreign trade is seriously impacted, then further disruption to the Strait stops having a negative impact internally, and a strategy change to active disruption becomes profitable because it has negative impacts on other players. NATO has indeed played boldly and it remains to be seen how deep the consequences may be.
For now military action seems a remote hypothesis. Iran still has the ability to keep the Strait open to its ports, in spite of the sanctions. And naturally Iran can always at some point decide to abide by the inspections from the IAEA. Likewise, from the NATO side, military action appears an unlikely scenario, as Iran’s prolific military technology seems a deterrent on its own, to which can be added the unpredictable reactions from other major players at the global scale.
If a military conflict ever develops around the Strait of Hormuz on the wake of this new batch of sanctions, it will be a definitive clarification of power over the region. In the three decades following the proclamation of the Carter Doctrine, wars in the region raged for a total of twenty years. NATO imports ever less oil from the Persian Gulf and its economic might has clearly waned during the last decade. Is the Carter Doctrine still affordable these days? Is it even practicable? A military clash at the Strait of Hormuz will certainly answer these questions.