Five Energy Supply Surprises from the Israeli/Iran Conflict

Director’s Blog XVIII by Stephen V. Arbogast

The twelve-day Israeli campaign against Iran’s nuclear and other facilities has paused for the moment.  Damage assessments of various sorts are underway.  Most are properly focused on the extent of destruction at Iran’s enrichment sites and weapons manufacturing centers.  Another assessment of interest, that of the implications for energy security, has received less attention.  What discussion has ensued has focused on Iran’s threat to close the Straits of Hormuz and the fact that they either were unable to act or chose not to do so.

A closer look however reveals a surprising set of messages for energy security.  Below we outline the five biggest surprises of this sort, offered in order of the degree of surprise:

• Neither Combatant Nation Seriously Went After the Other’s Energy Assets:

There were minor reciprocal attacks on refineries, neither of which caused serious damage.  Beyond this, the big fact was that Iran’s oil industry, capable of producing 2.5 million barrels per day and exporting 2/3 of that, was left intact.  Kharg Island, its principal export terminal, was not touched.  The relevant question then is ‘why not?’

Two hypotheses apply here.  The first is that Israel and the Trump administration are holding these assets ‘hostage.’  President Trump has openly said that there are more targets the U.S. could hit if Iran seriously went after American forces in the region.  That retaliation has not materialized to any great extent.  Presumably these hostage assets remain vulnerable should Iran embark on a nuclear rebuild.  The second hypothesis is that Iran will need its oil revenues to rebuild within a more peaceful context.  President Trump makes no secret of his offered trade – Iran fully gives up its nuclear program in return for a path to economic recovery.  Whether that offer has a realistic chance of being accepted by the current regime is not the point; that is the offer on the table. Perhaps the idea in the background is that it will be seized by a different government convinced that a change must be made.  Both hypotheses probably apply.  To what extent is still TBD.

• China Served as the Unwitting Guarantor of the Straits of Hormuz

 In past years Iran made serious efforts to disrupt oil shipments through the Straits.  It has attacked vessels with its navy and mined the Straits to deter ships from passing through.  This time, its sole action was to disrupt navigational aides to transiting vessels.  This proved a minor inconvenience.

While it is too early to evaluate what stayed Iran’s hand this time, it is not too early to observe certain facts which may have influenced Iran’s thinking.  Iran continues to struggle under sanctions that severely restrict the number of nations willing to be its customers.  China has been the principal exception, in some months buying most of the 1.7 MB/D that Iran can export.  Even in months where China’s purchases dropped below 1 MB/D, the suspicion remains that much of the displaced supply still found its way to the China market.  One route appears to have been shipments to Malaysia, from which the oil was merged with other supplies and re-routed to China.

China’s economy depends on 11 MB/D of oil imports to keep running.  A loss of almost 15% of its physical supplies plus the price shock associated with that disruption would be a harsh blow to a Chinese economy struggling with sub-standard growth, tariff disruptions and a property bust.

Iran is a country with few friends.  It is almost universally reviled by its Sunni Arab neighbors.  One principal friend, Russia, is bogged down in Ukraine and offered Iran nothing beyond rhetorical support.  China is the one major friend left that has financial resources and know-how to help Iran rebuild.  China too has only offered rhetorical support, but behind the scenes it may well have lobbied hard against Iranian actions in the Straits and conditioned future assistance on its wishes being respected.

• OPEC’s Recent Supply Moves Were Probably Orchestrated with an Iran Attack in Mind

 We are into a more speculative realm here, but there is little doubt that considerable ‘behind the scenes’ maneuvering went on before Israel launched its attacks.  One step which has not been connected to the Israeli assault was OPEC’s May decision to increase oil supplies, bringing down prices.

Here are the facts.  This year OPEC, dominated by Saudi Arabia and the Persian Gulf exporters, has held up to 5+ million barrels per day (MB/D) off the market to support prices.  Then, on May 3, 2025, it suddenly announced quota increases amounting to 411 thousand barrels per day (kb/d) for both June and July.  On May 13-16, President Trump visits the region, stopping in Riyadh, Doha, Dubai and the U.S. military base in Qatar.  On May 31, OPEC reaffirmed its 411 kb/d supply increase for July.

The most plausible explanation for what unfolded is that Israel was already sounding back-channel alarms about an Iranian sprint for the bomb and signaling its intention to strike.  Diplomacy still had some time to run, but contingency planning suggested softening and reassuring the oil markets in anticipation of possible military action.  Doing so would limit any oil price spikes, which had they occurred might have pressured leaders to curtail the military campaign before it had achieved its objectives.

That certainly is how events played out.  The WSJ event published a piece entitled ‘The Oil Price Spike that Wasn’t.’  There are two possible explanations here – one is that of coordinated contingency planning among the states highly interested in limiting Iran’s nuclear program and support of terrorism.  The second is that all these events were just coincidental.  In grave matters of statecraft, there are few such coincidences.

• American Energy Independence has Freed Up its ‘Hard Power’ Foreign Policy Options

During the 1973 Arab Israeli war, Saudi Arabia and it Gulf allies declared an oil embargo against the US and the Netherlands.  Reportedly, President Nixon considered military action against the Saudi oil fields at that time but rejected it as too risky.  That was a moment when US import dependence was growing.  Nixon judged the risks of greater supply disruptions and price hikes as too severe to accept.  The U.S. continued to suffer the embargo, gas lines, and 300+% price hikes until well after the war ended.

In the current moment, President Trump was able to take military action confident that there would be no supply shortages in the U.S.  Domestic production of 13 MB/D, plus 5-6 MB/D of natural gas liquids, plus dedicated imports from neighbors Canada and Mexico, plus hemisphere supplies from Guyana and Brazil assure both secure physical supplies and the ability to profit from price spikes.  The US not only exports light crudes in profitable trades while importing lower cost heavy materials but also exports copious amounts of higher value refined products and petrochemicals.  Thus, even a crude oil price spike, while painful for motorists at the pump, would not be destabilizing for the U.S. economy as a whole.

As a final point, the U.S. role as a prolific oil and gas exporter gives the President cards to play in any prospective oil supply scenario.  Both friends, e.g., Europe and Japan, and foes like China face serious consequences from supply disruptions.  Staying on the good side of the U.S. or at least staying largely quiet, helps assure these states that access to U.S. supplies will not suffer interference.

• Oil Sanctions Relief or Intensification will Be the Next Sub-text in Negotiations

As noted above, Iran’s oil production/exporting assets were not attacked, and the country remains under serious sanctions which hinder but do not stop its export trade.  Before the Israeli attack, Iran’s exports average ~1.7 MB/D with a peak of 2.2. MB/D.  Almost 90% of this found its way to the China market.

The current sanctions story is both the U.S., and the EU prohibit imports of Iranian crude oil.  Moreover, they deny marine insurance to vessels seeking to trade in Iranian oil, and aggressively seek to identify, hinder and even seize ‘ghost fleet’ vessels surreptitiously carrying out Iranian trade.

These measures have caused Iran’s ‘friends’ to adopt the following measures.  China has routed most Iranian supplies to ‘teapot’ refineries, i.e., small ‘independent’ facilities not directly associated with the big national oil companies.  Ghost fleets have adopted various alternative schemes to acquire marine insurance and hide their ownership.  Friendly states, e.g., Russia and Venezuela, have aided Iran with storage, transshipping and barter arrangements.

In return for its oil buyers circumventing the sanctions, Iran’s suffers ~$7-8/b price discounts.

These conditions provide the U.S. and EU with both carrots and sticks in future negotiations with Iran.  In return for a convincing surrender of its nuclear plans verified by unobstructed inspections, Iran would be allowed to again sell oil openly to any buyer.  It could increase both volumes exported and eliminate the current price discounts.

Alternatively, efforts by Iran to resuscitate its nuclear program could be met with heightened sanctions enforcement, including naval interference with tankers calling at Kharg Island and arresting of ghost fleet vessels.  Military devastation of Iran’s export facilities would be the ultimate step to deny it funds for rebuilding enrichment facilities.

In this regard, Israeli intelligence penetration of Iran is a critical new fact to consider.  The Iranian regime has been revealed as having been deeply penetrated by both Israeli agents inserted into the country and by disillusioned Iranian figures within the government and military.  There has been talk of ‘regime change.’  This has led to forceful arguments that such efforts, e.g., Iraq, are fraught with risks of ‘never ending wars.’  In this case however, it may be enough simply to maintain deep penetration of the current Iranian regime, so that accurate knowledge of the facts on the ground can enable timely preemptive actions against any rebooted nuclear program.

In time, that may be enough so that a regime which has brought Iran to this condition at such a cost will become subject to its own internal dynamics of change.

Conclusion: A proactive U.S./Israeli policy can cement the prospective security gains from the 12-day conflict.  It need not consider the kind of interventions which characterized the Iranian coup in 1953 or the 2003 overthrow of Saddam Husein.  Instead, having drawn a ‘red line’ around an Iranian nuclear program, it needs to continue enforcing that line. Iran’s energy assets can be held as a hostage to enforcement.  Indeed, tightened sanctions enforcement would be recommended right now.  It will demonstrate to Iran that its pathway to nuclear reconstruction is severely constrained financially while accentuating the upside for this or any subsequent Iranian regime that makes the decision to ‘normalize.’