Renaissance asks: Should we fear an Iranian revolution?

Charles Robertson at Renaissance mulls the most likely outcome of the ongoing Iranian nuclear crisis.

There are four scenarios for Iran and the market is focusing on the least likely: an Israeli attack on Iran’s nuclear facilities that might lead to Iranian retaliation against other regional oil producers. It is a scenario in which oil prices could echo the $180/bl average price equivalent that was last triggered by the Iranian revolution in 1979-1980. It would be a short-term positive for other oil producers such as Russia, Kazakhstan and Nigeria; but as in 1980, it would probably trigger globally high inflation, a US recession that in 1980 resulted in unemployment hitting 10.8% and would not be great for the re-election prospects of a US Democrat president. It could be a boom-and-bust story for oil producers as the global economy shrank.

Less improbable than an Israeli attack, in our view, is another Iranian revolution. Iran’s parliamentary election on 2 March will be the first electoral test for the regime since the 2009 presidential elections led to widespread long-lasting demonstrations. While the risk of a revolution is low (see below), it is an event with a significant tail-risk, unless such a revolution was peaceful.

Usually political transition at high income levels (Taiwan in 1992, Czechoslovakia in 1989) is peaceful, but Libya has proven to be an exception – albeit one heavily influenced by external factors. A peaceful revolution is clearly possible in Iran and the ideal scenario for markets, as it would 1) not disrupt either Iranian oil supplies or other regional oil suppliers and 2) lay to rest Israeli fears about nuclear weapons. The last Iranian revolution shut down the Shah’s nuclear weapons programme for nearly a generation. Oil prices would price out the $5-10 geopolitical premium (but not the global money-printing premium on oil).

Even a violent Iranian revolution would be less-disruptive for the global economy than it was in 1979-1980. Iranian net exports were 5Mb/d until 1978, or 8% of global demand, but fell to 2.5Mb/d in 1979 and then 0.9Mb/d in 1980 (the 4Q80 Iran-Iraq war worsened the situation). In 2010, Iranian oil exports of 2.4Mb/d represented 3% of global oil demand. The loss of perhaps 2Mb/d would send oil prices higher to perhaps $140-150/bl, but we doubt as high as $180/bl levels for a year, especially as global oil reserves are higher now The US can release 4Mb/d to offset lost Iranian production for two months.

The most likely scenario is of course no change in Iran’s political situation and no Israeli strike, and oil prices at $110/bl as per our house view in 2012 and $100/bl in flat real terms beyond this. However, pressure is intensifying on Iran and the threat of an Israeli strike may be a tool to encourage greater economic sanctions. Already talk of sanctions in December led to a currency collapse, which the central bank only reversed by hiking interest rates by 600 bpts to 23% – not a good pre-election strategy for any government. High inflation and the 17% of the population who are young men (more than in Tunisia, Egypt, Syria or Libya) are underlying factors that could trigger unrest. The US is leading efforts to reduce Iranian oil sales.

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