What if the Ayatollah has No Clothes?

By Tim Pierotti

Technology driven paradigm shifts tend to happen like Hemingway’s description of going broke: “slowly and then all it once”. Over the past month, we have learned that the disparity between the weapons systems and military capabilities of Israel and the United States versus those of Iran may be far greater than was previously conceived. Israel has destroyed the military threat from Hamas, and more surprisingly, their preemptive war in southern Lebanon has decimated the threat of Hezbollah. Iran’s recent ballistic missile strike on Israel yielded no discernible damage. The history of war is an examination of the history of evolving technology. There is an argument that Iran has been restrained and held back some of its most advanced weapons as they wish to avoid a direct confrontation with Iran and the United States. While that may be true, that restraint is an acknowledgement that the “Ring of Fire” is no longer a powerful enough deterrent to Israel attacking Iran’s domestic military and energy infrastructure.

Those who have been energy investors for a long time can recall the trajectory of fracking. For many years, fracking looked like a science project that would turn-out like so many money incinerating long-term projects in the oil and gas industry. Then it worked and it changed the world. Natural gas went from trading north of $7 to its current steady state between $2 and $3. It would be far lower if natural gas wells weren’t capped all across this country. Liquefied natural gas terminals that were being built for the import of natural gas suddenly had to reverse the process and orient the facilities for export. Fracking has allowed the US to almost double our oil production from 7 million to 13 million barrels a day. The innovations in the oil and gas industry that most industry analysts assumed to be a waste of money, led to a powerful growth accelerating and inflation deflating force that will persist for decades.

Prior to the unveiling of ChatGPT, experienced semiconductor analysts covering Nvidia believed that the future of the company would be driven by the gaming and crypto currency industries. Large language models and AI, as we conceive of it today, wasn’t thought to be an immediate demand driver of the company’s GPU’s. Suddenly, there is a new technology that many technologists and economists believe will alter the productive capabilities of the global economy.

As was the case in the fracking and AI revolutions, we think a paradigm shift may be taking place in the Middle East. The balance of power has been altered. The threat of mutually assured destruction between Iran and Israel has been removed. Never has it been remotely as likely that Israel will attack Iran with the intent of once and for all ending that country’s threat.

The issue for markets isn’t about a geopolitical event. For good reason, investors have learned to ignore “events” as they rarely last and if they do, don’t tend to hurt risk assets. The risk is that there could be a geopolitical paradigm shift unfolding. Iran exports roughly 3 million barrels of oil per day. Iran’s oil facilities lay along the Persian Gulf where roughly 20% of the worlds oil and oil products pass through daily. If Israel wants to meaningfully and permanently weaken Iran, and they do, they will cripple that energy infrastructure that invariably will cripple the transport of oil through the Persian Gulf and through the Straits of Hormuz. Some reading this may find this view na?ve. The recent history of the Middle East inform us that the Saudis and other Gulf states are loathe to see any risk to the free transport of oil in the region. But times change and the evolution of technology accelerates that change. Israel appears determined to seize upon their newly found advantage.

Oil is always the unknowable variable to those assessing the global economy. Perhaps the US and the Saudis will convince Israeli leadership not to attack Iran’s energy infrastructure in the near future, but from my perspective such an event is only a question of when, not if. And when it does happen, it will not be an event, but part of a paradigm shift that could change oil markets permanently.

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