You Can’t Always Get What You Want; The Emerging World Order

Overview

“You can't always get what you want. You can't always get what you want, but if you try sometime, you'll find, you get what you need ….”

Just like the lyrics of the iconic Rolling Stones tune, it is becoming increasingly obvious that what the West wants, it probably won’t get. Just like the lyrics, hopefully it gets what it needs. This installment addresses one of the most critical issues facing sophisticated institutional investors and risk managers over the past several years. We aim to provide a framework for evaluating some rapidly developing events.

A Few Givens

Our premise is that developments in the Middle East will have a major impact on the markets for the foreseeable future. Perhaps the best place to start is to review some basic assumptions:

1. Iran cannot easily be conquered – with over a million men in arms, mountainous terrain, a multitude of drones and missiles, and no obvious location for launching an attack, there is little possibility of landing sufficient troops to affect a regime change. While U.S. and Israeli strikes have successfully targeted senior Iranian leadership and degraded portions of Iran’s military infrastructure, the results have fallen short of initial expectations. Iran’s command and control structure appears to be far more distributed and resilient than hoped. Further, there are few reports of local uprisings.
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2. No Willingness for Boots on Ground – neither the US nor Israel has or is willing to devote the hundreds of thousands of troops, which would probably be needed to challenge the current Iranian regime.
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3. Controlling the Strait of Hormuz is relatively easy – a few easy-to-conceal drones or missiles can attack oil tankers in the Strait. Furthermore, a near miss is probably enough to curtail critical insurance coverage.
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4. The Existing Damage will take Years to Repair – investigating, designing, procuring materials, and rebuilding the infrastructure (pipelines, refineries, energy fields, gas condensation plants, etc.) will take years even if the parts and specialists are currently available (which they are not).
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5. Increased Energy Demand and Reduced Supplies – even excluding the massive additional demands resulting from data centers, the global energy supply chain is hard pressed. Our understanding is that Europe and India have merely two months of energy supply on hand.
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6. New challenges near the Red Sea – the Houthis have attacked shipping in the Red Sea and sent some missiles into Israel. Iran might encourage the Houthis to continue attacks to pressure the US and Israel. The Houthis, based in Yemen are allied with Iran and have previously attacked ships in the Red Sea. Approximately 4M barrels per day flow through the Bab el-Mandeb Strait, which is to the south. Since 2023, the Houthis have attacked 178 vessels.
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7. Cash Crunch in the Gulf – many countries in the Gulf are dependent on energy revenues, and for over three weeks have received significantly less than usual as a result.
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8. Futility of Escalations – while the US has “bombed our little hearts out”, getting all the missiles and drones is unrealistic, and only a few are needed to shut down the Strait.
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9. Assassinations Have Not Worked – the hope was that a removal of leadership in Iran would cause a collapse of the regime or at least, the emergence of a more palatable leader. That appears to have not happened, and if the more radical Mojtaba Khamenei remains in power, perhaps the reverse is true.
   

Countering the Attacks

Ukraine has been dealing with Shahed drone and missile attacks for the past several years with some success. However, the situation on the Strait is different in the sense that even if one in four attacks is successful, it will probably be sufficient to make vessel insurance rates prohibitively expensive, and Iran has multiple tools for the attacks: drones, missiles, and fast-boat delivered missiles and torpedoes.

Energy Crunch

With the Strait of Hormuz effectively contested, energy markets remain under sustained pressure. Europe’s starting position is fragile: EU gas storage at 28% of capacity is well below the multi-year seasonal average, and the EU has moved to ban Russian LNG imports by the end of 2026 and pipeline gas by autumn 2027, further constraining alternative supply. A major LNG exporter has stated that it cannot fulfill contractual commitments following attacks on its export facilities, and repairs may take years. Financial analysts warn that European storage facilities will need to attract LNG shipments away from other global buyers to achieve adequate filling before next winter, and under more adverse scenarios, including prolonged closure of the Strait, prices could reach levels reminiscent of the 2022 energy crisis. India, which imports 88% of its crude with more than half originating in the Middle East, faces parallel vulnerabilities. Its strategic petroleum reserves are only two-thirds full, and 90% of its LPG imports transit through waters now under threat. The European Central Bank has already set aside expectations for rate cuts, and multiple institutions now anticipate rate increases in response to energy-driven inflation.

Tentative Conclusion: Stalemate

The next action appears to be the US’s taking or bombing Kharg Island, which is in the Persian Gulf (northwest of the Strait of Hormuz) and is an export hub for 90% of Iran’s petroleum. The taking of the island will restrict energy exports from the island, but presumably, if taken, could be attacked by missiles and drones.

Iran possesses over 1,100 miles of southern coastline along the Persian Gulf and Gulf of Oman, providing an enormous and dispersed launch surface for drone and missile attacks. Any U.S. forces stationed on or near Kharg Island would represent a concentrated, stationary target well within range of Iran’s arsenal, which can be resupplied in short order with cheap drones.

This asymmetry is a defining feature of the conflict: strike capabilities are cheap, easily concealed, and widely distributed across rugged terrain and underground facilities, while the targets they threaten (aircraft carriers, island garrisons, forward operating bases) are expensive, highly visible, and difficult to defend. Satellite imagery and proliferating surveillance drones only compound this vulnerability.

Trump appears unwilling to destroy the island's infrastructure, as it would lead to a sustained elevation in energy prices and would remove a chip for potential future negotiations. However, taking the island and holding it appears to be a difficult prospect, considering the difficulty the U.S. faces with Iranian attacks on its bases and threats to its ships.

Ending the Stalemate/ Gradual Acceptance

Iran wants to continue its existence as an independent state, to end sanctions, be allowed to develop nuclear weapons (which it presumably believes will ensure its sovereignty), tax transit through the Persian Gulf, and ideally, drive the U.S. out of the Middle East. Of course, Israel and the U.S. want the exact opposite. Hence, the war.

Die is Cast

Even if the conflict ends tomorrow, there are numerous actions that are increasingly likely:

• Restricted Energy – at a time when demand for energy has increased substantially, flows from the Middle East are being curtailed.
  

• Pain in Europe and Asia – Given the abundance of energy in the US and Canada, it will be Asia and Europe which are likely to suffer the most and face rationing.
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• Economic Disruption – The Gulf countries have experienced significant disruption in revenues and will need to sell assets and/or borrow to maintain services.
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• Inflation and Interest Rate Pressure – Energy costs impact nearly every industry and the increases in energy prices are likely to be reflected in inflation statistics. While inflation is normally driven by increased demand, here it would be based on increased costs. Hence, treasury yields might rise but presumably central banks would be more forgiving.
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• Industry Dislocations – Those industries which are heavily dependent on energy costs (e.g., airlines, trucking, and utilities) are likely to suffer.
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• Radicalization – radicals are typically born out of a sense of frustration whereby there is nothing to lose. Given the massive harm caused to many by this war, the risk of attacks might increase.

Partial Resolution

Japan paid millions to ensure energy was safely shipped through the Strait of Hormuz, and India and China are likely to do the same. Perhaps this is the new model although the other gulf countries might return the favor and do the same to Iranian shipments. Economically, it translates into increased costs for utilizing Middle East energy beyond the relatively low extraction costs.

Conclusion

The continuation of the war is in no one’s interest, but it might take time to work out new conditions. In the meantime, the war and its consequences are highly relevant for sophisticated institutional investors and risk managers. If this war paves the way for Iran’s becoming a nuclear power, the risks of future conflicts escalate while hopefully the probability of such conflicts decline. The diminishment in recent strikes is encouraging.