Iran war part 4 - The coming economic shock.
At the time of writing this, the Iran war has resumed for 14 days and it is a good opportunity to
review my previous assumptions made about the war and on India’s oil security.
14 days of consecutive fighting (not brief fighting during a ceasefire) is
enough time for the conflict to take on a shape that one can draw conclusions
from.
This is a continuation from the two previous articles in this series, focussing
more on the economic consequences of the war an how they might shape military
operations.
https://rpdeans.blogspot.com/2026/05/iran-war-part-2-calm-before-storm.html
I had made the following predictions:
1. Iranian oil wells (production) will not
irrecoverably collapse from ending exports, because most oil produced is
consumed domestically (thereby oil wells will produce more than their minimum
viable output). This was correct.
2.
Iran would not feel the loss of oil revenue
until mid-June, at the oil prices prevailing before
the war. At higher oil prices, this point would have been reached in the
beginning of August,
after the ceasefire. This was correct. The Iranian leadership did not panic in
the run up to the ceasefire. The US blinked first – based on Trump’s statement
that US oil reserves would have been depleted below levels that would have
caused oil markets to panic – by mid-July.
3.
The Gulf states economies would be impacted more
than Iran’s. This was correct. In the current round of fighting, there were
negligible Iranian attacks on the UAE and Qatar and no
US attacks from their territory, probably due to a tacit understanding with
Iran to avoid further damage to their energy exports and economy. The Saudis
have attacked the Houthis in Yemen (and vice versa) without a direct attack on
or by Iran.
What was unexpected:
1.The fall in oil supply did not lead to the anticipated
surge in oil prices, because Chinese imports slowed. China imported between
11.4 – 11.8 million barrels per day (MBD) between Dec '25 and
Mar '26. Although
the war impacted supplies from the beginning of March, China’s March imports
represented crude oil already at sea (as did India’s). In April, China’s
imports were 9.37 MBD and in May around 7.9 MBD.
Chinese refinery output however, continued to be between 13 - 13.8 MBD (13 MBD
represents local production of crude + imports) with a slowdown to 12.7 MBD
only in June.
Thus, China did not increase imports from other sources to make up for a drop
in Gulf oil but
depleted their strategic reserves, which were over 1000 million barrels
pre-war.
June is maintenance time in China when refineries have lower than average
output, coupled with export restrictions on refined product from China,
something I argued, in my article that India should have implemented to a
greater extent than we did.
2.After the ceasefire, the UAE restored its pre war oil exports. Kuwait and
Iraq, have exported less than half their pre war levels, probably (as suggested
in my earlier article) because the MSFR (minimum stable flow rate) of oil wells
could not be met.
There is limited storage capacity for oil in all gulf countries barring
Saudi.
Oil pumped out from a well has to be transported to a refinery. Oil wells have
to pump our at least a third to half the rated output of the well, to avoid
damage to the well. In practise some wells would be kept above MSFR and others
allowed to fall below that level with a drop in output of several weeks – or
longer, if engineers are not available.
Reasons the war restarted
- It was seen as a terrible deal negotiated by President Trump’s team, by his
own base, no matter
what spin he put on it. That gave Trump little incentive to continue the
ceasefire, particularly if it
was suggested that more attacks would force Iran to concede better terms.
- Israel had not completed operations in Lebanon, aimed at completely
neutralizing Hezbollah,
securing its northern border, by occupying South Lebanon and involving the
Lebanese and Syrian governments in taking on Hezbollah. At the time of the
ceasefire, IDF units were stuck in a zone in south Lebanon, smaller than they
would have liked, under constant drone attack – which hit large
numbers of vehicles, though with few casualties. They were under pressure to
stick to a ceasefire.
Restarting the war gives Israel freedom of action in Lebanon. If Iran is indeed
compelled to accept terms more favourable to Israel/US, that helps Israel,
without any cost to itself.
- Iran had no reason to restart the war, having got a better MOU than they
probably expected. My sense is the US kept pushing the envelope by sending
ships through the strait of Hormuz without
coordinating with Iran. On three occasions Iranian retaliation against ships
led to US missile attacks on Iran, with neither side causing significant
damage. The hitherto carefully orchestrated escalation
broke down possibly when Trump decided on stronger retaliation and hardliners
in Iran decided to
reply in the same manner.
What to look out for.
1. US strategic oil reserves, which were 397 million barrels on 24th
Aril, were 311 million barrels
on 21st July. Officially, a 70 million barrel equivalent of this
reserve cannot be used as it is sludge at the bottom of the storage area. The
US petroleum reserve consists largely of 60 caverns designed to store oil for
25 years. They have been in operation for 50. The level of unusable oil will be
more than 70 million barrels. There is also the need for a reserve for the
military, hence the US is not allowed to draw down oil in excess of a reserve
of 250 million barrels.
The US strategic petroleum is already at its lowest level since 1983 (when
consumption was half current levels) and once it reaches around 230 million
barrels, the US effectively has zero reserves. Oil prices will start increasing
in anticipation of that. Even before restarting the war, this reserve was being
depleted by 5 million barrels a week.
The rate of depletion of US reserves is exacerbated by the start of hurricane
season in the Gulf of Mexico, which has shut drilling on some offshore
platforms and a fresh closure of the strait of Hormuz and the Bab El Mandeb
strait by the Houthis. At a drawdown of 8 million barrels a week
US reserves will hit zero in 10 weeks, but oil prices will spike before
that.
2. The blockade of the Bab El-Mandeb strait. This
affects the flow of 6 MBD of crude oil and 0.6 MBD of refined oil products, passing through the strait. Half of this is
Saudi oil from the oil terminal and refineries at Yanbu. This was unaffected in
the first round of fighting.
There is an alternate route for Saudi oil passing through the strait, which is
to go North via the Suez canal. However, VLCCs (very large crude carriers)
cannot use the Suez, unless some of their oil is pumped out overland (SUMED
pipeline). There is a shortage of smaller capacity tankers to carry oil visa
Suez. The remaining oil is mostly from
Russia, which is unaffected by the blockade. There have also been attacks on
the ARAMCO refinery and the east west pipeline transporting oil from Saudi’s
eastern oilfields to Yanbu port in the west. Once oil already at sea has been
delivered, there will be a
medium term shortfall of 1 MBD of Saudi oil, due to longer transit times (1
month more to Asia), shortage of VLCCs and shortage of smaller capacity
tankers.
3. Refined oil shortage. Attacks on Russian refineries by Ukraine have
led to a ban on refined oil exports by Russia – they turned a net imported of
refined products in June. Saudi’s ARAMCO refinery
was hit for the first time by the Houthis on 24th Jul. This will
mean a shortage of refining capacity as bad as the crude shortfall. The problem is not the damage suffered by a
refinery in a single drone or missile hit, but the willingness of its people to
continue working, protection of oil tanks etc, which can mean refineries remain
offline for weeks. In the US, the `crack spread’ (or refining margin) is at its
highest. An article from Nobel laurate Paul Krugman, explains crack spread.
https://paulkrugman.substack.com/p/quagmire-of-the-vanities
4. Other oil shortfalls: After Ukrainian attacks on Russian port and oil
terminal infrastructure in July, Kazakh oil exports (which can only be exported
through the Caspian Pipeline consortium – CPC through Russian ports) fell by
appro 0.4 MBD.
How long can this last:
Iran: Before the ceasefire, Iran could export oil till around 15th
July (which was when the oil it had at sea would be emptied and no fresh
shipments were possible due to the US blockade of the coast. The ceasefire
enabled shipments equivalent to another 10 weeks of oil revenue. In addition,
some exports across the Caspian sea and by land to Pakistan, will give Iran
approx. 3 months of oil revenues. If any of the frozen funds sought to be
unfrozen and returned to Iran after the signing of the MOU were returned, that
will be an addition. The first tranche of such funds was to be $6 billion
(of $12 billion listed in the MOU and approx. US$100 Billion frozen in all).
Qatar denied transferring it, but there is no clarity at the time of writing
this.
At the current rate of firing and estimated production, Iran’s drones and
missiles will last for about 6 weeks – with 6 weeks equivalent kept in reserve
to counter a possible US ground operation.
The US: The US timeline is affected by two things:
- The price of oil. In March ’26, after 3 weeks of fighting, prices of crude
rose approx. $38/barrel
(from $ 73 - $ 111/ barrel) but moderated to $ 99 at the time of the ceasefire.
In the current fighting
oil has increase $30 /barrel in 3 weeks, but in my view will continue to rise,
as a result of the closure of the Bab El Mandeb strait, the depletion of the US
strategic reserve and a fall in Kazakh oil output. The prices of refined
product have already risen at a faster rate, due to damage to refineries in the
Middle East and Russia. Thus diesel prices in the US are higher on 24th
July than when crude oil was $20 /barrel higher – at its peak during the first
round of fighting.
The inflation on petroleum products is taking place along a fresh set of
tariff’s (between 10-12.5%) set to replace the earlier 10% tariff which expired
and in many cases was considered temporary and not passed on to the end
consumer.
-The depletion of US missiles and diminishing returns. The
stock of long range missiles to hit Iran is
already below the minimum level required to fight a major adversary (China or
Russia). The stock of
interceptors (Patriot and Thaad) missiles is similarly depleted, resulting in a
lower rate of interceptions of Iranian missiles and drones. Simply continuing
the daily attacks on each other’s infrastructure is resulting in diminishing
returns for the US – There are fewer military targets on the ground left to
destroy and a higher `hit’ rate for Iran, with fewer missiles and drones
intercepted.
Israel probably did not join the US when the war resumed (after strongly canvassing the US Congress to restart it) because they have a shortage of air to ground missiles and interceptor missiles to handle the inevitable Iranian response.
As the following article suggests, the US has started replacing long range guided
missiles like the Tomahawk with glide bombs, which have a far shorter range. It
will result in US aircraft moving into the range of Iranian air defences and
Iran shifting important assets further inland – out of the range of glide
bombs. The list of targets attacked each day also suggest that there are few
important targets left
e.g. a speedboat off Qeshm island – probably cost a fraction of the missile
that hit it. On the 25th for the first time, there were no US
strikes (without any talk of a ceasefire), suggesting the US was running out of
both missiles and targets.
https://simplicius76.substack.com/p/war-weary-trump-balks-again-as-advisors
The Houthis, who, as I covered in my earlier articles on the Gaza war, had a
terrible record hitting ships at sea with drones, were far more successful
hitting the ARAMCO refinery in Saudi in the absence of intercepting missiles –
the Saudis using most of them in the first round of fighting. Similarly, US
bases in Jordan, Bahrain and Kuwait saw a far higher proportion of Iranian
missiles and drones getting through. The
current tempo of operations is not bringing the US closer to achieving
its goals, while oil prices increase and there is growing resistance in the US
congress to finance the war – it is also the most unpopular war in US history
which reflects in Trump’s falling approval (also the lowest among any
President).
If not continue at the current pace, or a return to the MOU,
the only way the US can get a better outcome is to target Iran’s
infrastructure, like oil or power plants, or transport (bridges, ports). That
will lead to Iranian retaliation, against the infrastructure of the Gulf
states, which will cause far more damage. The other option is a ground
operation – against Kharg or Qeshm islands, or the coastal strip facing the
strait of Hormuz. This is a high risk operation and will most likely result in
what the US has not suffered so far, high human casualties and the loss of
ships.
The illusion of victory option: Given his past
statements and behaviour, Trump has the
option of a big strike against an Iranian facility which the media has hyped as
a leading `impregnable’ nuclear facility – Pickaxe mountain. If he hits that
and possibly other high profile targets like any of the regime’s leadership, or
other nuclear sites, he can say that Iran’s nuclear facilities are irreversibly
destroyed, sanctions will stay until Iran accepts his terms and the US has won
`bigly’. Oil prices will also fall. The strait of Hormuz – as Trump has
repeatedly said, is of no importance to him (it mattered only to the extent its
closure affected oil prices). This will mean a return to the pre war position,
except that Iran will control the straits, its missile and nuclear program will
continue (with the current supreme leader Mojtaba Khamenei being more amenable
to developing nuclear weapons than his father).
This option will be
opposed by both Israel and the Gulf states – who will have to face a more
confident, aggressive and vengeful Iran, without stocks of interceptor missiles
and a reduced US presence in the region.
Russia can only manage the continued financing of the
Ukraine war (without significant cutbacks to
social spending) if oil prices remain at the current level Russian energy
revenues from Jan-June 2026 were 11% lower than 2025, at current oil prices, it
will match 2025 revenues for the Jan-August period by end August. China
has a strategic oil reserve of an estimated 1100 million barrels. They can
comfortably draw down this reserve to meet a shortfall from the middle east, of
2-3 million barrels a day (making up some of the Middle East shortfall from
Russia), for at least 3 months.
I had speculated in my previous article on this conflict that China could try
and break the US blockade (illegal under international law) of Iran by sending
their tankers and ships with humanitarian aid, with tankers stocking up on oil (in
a barter deal), escorted by Chinese warships. In that situation I do not think the
US will risk war with China – the US breaking the 1948 Soviet blockade of
Berlin is a precedent for this (as was Russia sending an oil tanker to Cuba
recently).
China did not do it earlier, as the US declared a ceasefire. They are more
likely to do it after Sept, once the US position is weaker and Trump cannot
risk a wider conflict close to the mid-terms.
While Russia and China want the conflict to conflict to continue for some time,
perversely Israel (the closest US ally in this conflict) also wants to
continue the conflict, with the aim of eliminating Iran’s nuclear and missile
threat once and for all, ridding South Lebanon of Hezbollah and as a secondary
objective, leave the Middle East economically weaker from a prolonged conflict.
The army has been in constant combat since Oct 2023. Currently, formations from
south Lebanon are moving to the West bank to handle new outbreaks of violence. Israel’s ruling alliance is likely to lose
the Oct elections, unless Iran and Hezbollah are neutralized and the army
returns to peacetime deployment.
The coming oil shock for India.
My previous article looked at the situation in April, in detail:
https://rpdeans.blogspot.com/2026/05/the-coming-oil-crisis.html
The reduction in global supply is going to be worse than Mar-April, given the closure of the Bab
el-Mandeb and reduction in Kazakh exports and can affect India to a greater extent. There is a bigger reduction in refined oil output, given Russia's export ban and damage to gulf refineries.
There will therefore be an incentive for India (Reliance) to export refined products at higher margins.
Even if this export is taxed, any crude imported for export as a refined product, will come at the expense of the Indian consumer. Surplus refining capacity can instead be used to refine into LPG - where we will also face a shortage due to a stoppage of Qatari supply with long term damage to about a fifth of Qatar output and an increase in Europe's demand as winter approaches.
India normally exports 20 million tns of refined petroleum products each month (about 9% by tonnage of the total crude imported). In March and April 26, this figure dropped to 17 million Tns with additional quantities of LPG produced for the Indian market. However, in May, exports rose again
to 21.4 mil tns (18.4 million in June). Reducing exports by 4 million tons a month (20%) will mean an equivalent of 500,000 barrels of crude per day that can be processed for the Indian market.
There is an opportunity for the Indian Navy to escort tankers carrying crude for India, across the
Bab el-Mandeb strait, for loading at Yanbu. This is lower risk than attempting the strait of Hormuz - the Houthi's record of intercepting ships with missiles and drones is poor, as I had highlighted in earlier articles. Unlike Hormuz, this move will have the full support of the Saudis and the US. It is particularly important we do this, as no other NATO navy is attempting to break the blockade and the optics of India offering to help the US Navy ensure freedom of the seas, would probably be viewed very positively.
This is something the Pakistan Navy should ideally do, under their mutual defence treaty which makes it all the more important that India do it.
Pre war, India had 2.2 MBD of crude being supplied through the strait of Hormuz. We can make up this shortfall in the following way:
Russia - 0.65 MBD in addition to pre war purchases (Russia has no capacity to supply more).
We need to do this while the proposed US bill sanctioning those buying Russian energy is not under consideration.
Venezuela: 0.35 MBD Their high density grade of crude can be processed in our refineries (and not most others).
Saudi 0.65 MBD rerouted through the Bab El-Mandab, under Indian Navy escort.
UAE: 0.65 MBD from Fujairah - away from the strait of Hormuz but escorted by the Indian navy as
as precaution, This is 2.3 MBD in total, making up our shortfall.
Reducing exports of refined product by 20% will give us 0.5 MBD of crude which can be processed to LPG, making up our gas shortfall.
Further reading:
An analysis of Iranian missile attacks
https://simplicius76.substack.com/p/us-troop-casualties-pile-up-as-iran
Regular updates on operations
https://understandingwar.org/research/middle-east/iran-update-special-report-july-25-2026/
My earlier blog articles in this series:
Iran war - Part 1
The sinking of the Dena
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