In the absence of news of much economic significance (though UK car sales down 29% year-on-year in July, thanks largely to the continuing world shortage of semi-conductor chips was noteworthy), this week we focus on the growing geopolitical significance of Iran, not least that country having had the finger pointed at it twice in the space of a few days for attacks on international shipping in the Gulf of Oman, first with a ‘suicide drone’ (a small, low-tech guided missile, surely?) causing two fatalities including a British security guard on board an Israeli-managed oil tanker; second, the short-lived hijacking of a tanker carrying bitumen and asphalt.

A major regional power with global influences

Iran’s influence across the Middle East, Arabia and into central Asia is palpable and growing. Strategically, its geopolitical significance is obvious: sitting on the north shore of the Persian Gulf it controls the northern side of the Straits of Hormuz (which, along with the Panama and Suez canals, the Gibraltar Strait, the Bab al Mandab bottleneck at the base of the Red Sea, and the Straits of Malacca, is one of the six great global pinch-points for maritime trade) through which a fifth of all global oil shipments pass. On land, it shares borders to the east with Afghanistan and Pakistan and north-east with Turkmenistan; to the west with Iraq, and up in Asia Minor and the Caucasus with Turkey, Azerbaijan and Armenia, and it controls the southern shore of the Caspian Sea. To say it lies at the nodal point of a volatile region would be an understatement.

 

Economically, it ranks third on the list of countries with proven oil reserves, and second for natural gas reserves. Thanks to US sanctions and despite being a member of OPEC, it ranks only 9th in global oil production, with a daily output of around 2.7m barrels/day. Oil and related industries account for 15% of GDP, a long-term challenge as the world weans itself off fossil fuels over the next three decades (Iran is one of the very few countries of any significance not to have signed the Paris Climate Accord).

Seismic change in its geopolitical bearings since 1979

But it is the dramatic change in Iran’s political situation since the overthrow of the Shah in 1979 which has had the most profound effect both on its neighbours and further afield. Backed by the US and the UK, Iran under the Shah was a key western ally in the region. The Islamic Republic first under Ayatollah Khomeini, then his successors, is not only anti-western but profoundly anti-Zionist, committed to the destruction of Israel.

 

Further, within the Islamic world, Shi’ite Iran is at ideological loggerheads with Sunni Islamism, the dominant religion in Saudi Arabia, its principal strategic rival.

 

Iran is very aware of its importance and plays to its geographic and strategic strengths. The aftermath of the 2011 Arab Spring was a key moment in exerting and extending its regional influence. Deep failures of policy and understanding by the US, the UK and France following the Iraqi wars against Saddam significantly destabilised Libya, Egypt and Syria, with knock-on effects for Jordan, Chad, Niger, Mali and Nigeria. This allowed what had been isolated pockets of Al Qaeda, Daesh, ISIS and others almost to coalesce, giving oxygen to the Caliphate in the Levant and Mesopotamia. Recognising a threat to its own hegemony Iran joined forces with Russia, siding with the Syrian government in its conflict with the rebels and also driving out the Caliphate from the broader region encompassing parts of Syria, Iraq and threatening to encroach on Iranian territory.

Mischief abroad

However, elsewhere in the region, through the skilful use of proxies, notably Hamas in Palestine and the Houthi rebels in the Yemen, Tehran has funded, trained and backed militant groups hostile to the interests of Israel and Saudi Arabia. Tehran knows too that such policies would play well with the political left in the US and Europe. Their judgement was accurate, notably with the distinct cooling of sympathies in the Biden government for Israel and Saudi Arabia.

China and the US: polar opposite approaches

But it is the relationships with the US and China which are key, the former to contain a strategic threat, the latter to maximise its biggest strategic opportunity.

 

China and Iran have strong mutual interests, and it is no surprise that Beijing and Tehran have close ties. China is Iran’s biggest oil customer, accounting for around 20% of Iran’s production; equally in 2020 Iran was the third-biggest supplier to China, accounting for 11% of China’s oil imports. But longer-term, it is China’s One Belt One Road project which is the most important factor. As we wrote in June, the New Silk Road is substantially the world’s biggest infrastructure project. Its planned tentacles extend from China’s borders across central Asia to the Mediterranean and into Europe. It links China to all the countries along its route, and links all those countries to each other and then back to China. Whether through ports, roads, rail, air, power lines, water grids, fibre-optics, new cities, the centre of gravity is incontrovertibly China; if 2000 years ago, all roads led to Rome, China’s idea in the 21st Century is that all roads will lead to Beijing. But without Iran, which straddles the entire land corridor from the Persian Gulf to the Caspian, the project hits a dead-end; far from an integrated infrastructural super-highway it becomes nothing more than a central Asian cul-de-sac without even the benefit of India as a partner.

Actively hostile

If interests with China are interdependent, the opposite is true with the US. The outgoing Iranian administration was at best antipathetic to the US; the new one under hard-line ‘conservative’ Ebrahim Raisi is actively hostile. The focal point is Iran’s ambition to be a nuclear power, bringing it significantly increased leverage with other nuclear powers in the region: Israel, India and Pakistan, leaving aside Russia and China. The US having left the Joint Comprehensive Plan of Action (JCPOA) when Donald Trump was presented with incontrovertible evidence that Iran had been covertly flouting its nuclear containment goals, Joe Biden is now seeking America’s readmittance. With few cards to play other than sanctions, which Tehran holds in contempt, Biden is firmly on the back foot. It seems that within a week of taking office, Raisi is pushing all the buttons to provoke a reaction from the west, America in particular. Speculation is that Raisi is setting up the US to fail in negotiations, not only to present to the world that in Tehran, Washington has met its match, but also domestically to provide a convenient smoke-screen to cover political tensions following a divisive Iranian election. The greatest risk is Israel, also under a new administration, taking matters in its own hands either reactively or pre-emptively in a military or asymmetric strike which quickly escalates.

For investors?

Does this matter to investors? Obviously, it does if the bullets start flying; only last year, in January 2020 when a US drone assassinated Iranian General Soleimani at Baghdad airport in violation of US sanctions, the global oil price spiked. There have been other similar incidents with similar results. Beyond that, there is the risk attached to the general ratcheting of tensions. The US Navy already has a carrier group in the Gulf undertaking escort work through the Straits of Hormuz; Britain may have to commit a frigate or destroyer to such work too. Beyond these immediate and localised factors, it is the weighing up of the changing balances of power in a critically important but volatile region in which the geopolitical tectonic plates are perceptibly shifting and will shift again if Iran succeeds in becoming a nuclear state. These additional risks tend to be factored into long-term risk premia and financing costs over and above the risk-free rate of return (the accepted global proxy for which is the US 10-Year Treasury).

 

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.

The value of active minds – independent thinking:

A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.

Fund specific risks

The NURS Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request. The Jupiter Merlin Conservative Portfolio can invest more than 35% of its value in securities issued or guaranteed by an EEA state. The Jupiter Merlin Income, Jupiter Merlin Balanced and Jupiter Merlin Conservative Portfolios’ expenses are charged to capital, which can reduce the potential for capital growth.

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