SSIM: Iran’s fragilty implies durable risk premium in oil markets

19 januari 2026

Elliot Hentov, Head of Macro Policy Research at asset manager State Street Investment Management, analyses the impact of Iran's situation on financial markets.

Key take aways

• The Saudi–UAE divergence is now structural, enabled by Iran’s decline and visible in proxy conflicts in Yemen and Sudan, with potential spillovers into fiscal expansion which could in turn impact bond markets. 
  
  
• Iran retains credible oil-market leverage despite military losses, with the capacity to disrupt 2-3 mbd of production, making oil prices highly sensitive to shifts in perceived US intervention risk.
  
  
• Medium-term Iranian fragility implies a durable geopolitical risk premium for oil markets, as sustained instability in a 2 mbd exporter threatens up to 15-20% of global oil supply in extreme spillover scenarios, reinforcing higher structural volatility.

Regional fallout and shifting dynamics

Even before the recent protests geared up, the Islamic Republic of Iran had been greatly diminished over the past 15 months. With shifting dynamics related to recent events in Venezuela and Syria, and against the backdrop of military losses resulting from the 2024 conflict with Israel, Iran has been left with reduced air defense, partially destroyed nuclear infrastructure and a shrunken missile arsenal.

In short, it has become a weakened regional power. This power retrenchment invites other regional countries to step in and fill that vacuum, e.g. Turkey as Syria’s new patron. The other consequence is that it has diluted the cohesion of the anti-Iran bloc, especially in Saudi Arabia’s evolving foreign policy views.

In this regard, there has been a deviation of views between Saudi Arabia and the UAE, most visibly in their respective proxies now fighting each other in Yemen, to the benefit of the Houthis. A similar split has occurred in proxy support in Sudan. The details of the spat are less relevant other than noting that this rupture could not have occurred before Iran’s decline in 2025.

It is therefore a structural shift, likely to persist and involves the region’s two largest economies and capital markets. Hence, the transmission to financial services business could be material, with potential impacts on fiscal expansion which could in turn impact bond markets. 

Iran - Short-Term implications

Do Iran’s protests matter? The applicable historical precedent is just months away, namely the 12-day Israel-Iran war: what are the immediate pathways to spillover?  And like in most regions of the world that are less central to the global economy, the pathway is via Great Power involvement.

So, is the key question around the odds of US military action and potential Iranian retaliation? The latter is easier to quantify, with Iran’s short-range missile arsenal and launch capabilities overwhelmingly intact. If the regime feels existentially threatened – which it would under a US assault supporting a domestic uprising – then it would use that to target a) regional oil supply and b) US personnel. The defense strategy would be to impose costs on US intervention via higher oil prices as well as US casualties.

While the Maduro extraction was marginal for markets given that it only affected some maritime supply and Venezuela’s range of production (in total <500kbd of oil), Iranian retaliation could conceivably constrain 2-3 mbd of production, and possibly also substantial amounts of transit. So the geopolitical risk premium on oil should roughly parallel market odds of serious US military intervention.

This has now dropped as Trump has signalled less urgency for air strikes, leaving spot prices barely 3% higher than the day after Maduro’s removal. Figure 1 shows Oil vol (OVX) has just hit its post-12-day war high last Friday and I’d anticipate this has further to climb over course of the year, even if it normalises in coming days.

Iran Uprising – ‘What Next’ Is a Medium-Term Question

The Iranian regime has been shedding popular legitimacy over decades and responding with ever-greater repression, a dynamic that has contributed to the recent civil unrest. This does not necessarily portend regime collapse, but no country can maintain a functioning society and economy with such widespread antipathy among the population.

Absent any reform, Iran will therefore start to resemble Iraq under Saddam Hussein or Syria under Bashar Assad – fragile regimes whose fragility causes renewed conflicts, both internal and external. Given that Iran currently exports 2 mbd of oil and spillover conflict conceivably threatens another 15-20% of global supply, Iran’s instability will be a perpetual risk to oil markets. Over the medium term, such a scenario is a tailwind for a structurally higher geopolitical risk premium.