Iran is 'on notice': What Flynn meant and how the White House may have miscalculated

Trump: Nothing is off the table for Iran
Trump: Nothing is off the table for Iran

A White House warning to Tehran on Wednesday may cloud the outlook for foreign investment into Iran, but the Trump administration and its regional allies also risk playing into the Iranian regime's hands as it takes a more strident tone, analysts say.

The opening shot will do little to inspire investors to commit to new projects in Iran, which is trying to rebuild its oil and gas sector after years of sanctions. While that may put pressure on Tehran, President Donald Trump has virtually no support in Europe or Asia for new sanctions and may have missed an opportunity to contain the Iranian regime, analysts say.

National security advisor Michael Flynn put Iran "on notice" on Wednesday, citing recent ballistic missile tests and support for Houthi rebels in Yemen's civil war.

The United States is expected to sanction about two dozen Iranian entities as early as Friday, Reuters reported on Thursday, citing sources familiar with the matter. The White House did not immediately return CNBC's request for comment.

The biggest asset for any U.S. president in putting pressure on the Iranian regime is the people of Iran
Alex Vatanka
Middle East Institute senior fellow

National Security Council staffers offered few additional details during a conference call Wednesday, except to say the White House statement marked the beginning of a deliberation about "a large number of options" the administration can deploy to rein in Iran. They declined to comment on whether that included military options.

Staffers said Flynn's statement conveyed that the new administration is thinking about Iran in a different light than the Obama team, and they hope the message immediately dissuades Iran from future provocations.

A chilling effect

But the NSC staffers also stressed that they were not considering the Iran nuclear deal between Tehran and six world powers as part of the deliberations, perhaps suggesting the White House is backing away from Trump's campaign threats to tear up the accord.

Indeed, the European signatories, Russia and China all believe Iran is in compliance with that deal, which puts limits on Tehran's nuclear program in exchange for sanctions relief. That suggests any new sanctions would likely be unilateral, said Greg Priddy, oil market analyst at the Eurasia Group.

The question is whether those sanctions would target individuals and businesses or aim to damage Iran's economy at large, he said. The impact of the latter could be minimal because the United States does little trade with Iran, he noted.

But new sanctions could still have a chilling effect on banks that would otherwise fund Iranian projects and the oil giants seeking to develop Iran's huge oil and gas reserves. The Obama administration actively assured foreign banks it was safe to do business in Iran after international sanctions were lifted, but Trump is unlikely to follow suit, Priddy said.

Iran relationship a black swan for oil?
Iran relationship a black swan for oil?

"I think there's still a lot of interest in the industry, but this reinforces our view that the [international oil companies] are going to be very cautious," he said. "I don't think you're going to see these move forward to binding contracts and development in the next year or so."

Helima Croft, global head of commodity strategy at RBC Capital Markets, said Iran watchers may be underestimating the potential impact of sanctions, especially if the United States pursues measures that disrupt other countries' ability to do business with Iran through international financial channels.

That could be a risky move. European allies of the U.S. pushed back against previous attempts to impose such sanctions. They only came on board once details of Iran's covert nuclear program came to light.

Miscalculating Iran-Saudi rivalry

Any outcome that put fewer Iranian barrels into the oil market would be a boon to Saudi Arabia, the world's top oil exporter and Tehran's chief regional rival.

Last week, Saudi Foreign Minister Adel bin Ahmed Al-Jubeir said the kingdom is "largely in accord with Trump's stated policies," according to a briefing on his statement from the Saudi U.S. Embassy.

One week earlier, Al-Jubeir issued a warning on Iran at the World Economic Forum similar to Flynn's, saying Tehran must be held accountable for supporting terrorism, violating a U.N. resolution on ballistic missile tests and intervening in neighbors' affairs.

Flynn's focus on Iran's role in prolonging Yemen's civil war also brought Riyadh and Washington into closer alignment. While President Barack Obama backed the Saudi-led coalition in Yemen, his administration angered Riyadh by raising concerns about the high civilian death toll and reportedly blocking arms sales to the kingdom at one point.

The Saudis have pummeled their southern neighbor in an effort to oust Houthi rebels who staged a successful coup two years ago. Iran has backed the Houthis, but the depth of its support is in dispute.

NSC officials on Wednesday cast the Yemeni-Iranian relationship as strong and indisputable. They said Iran's support was a growing concern after Houthis allegedly fired rockets at a United Arab Emirates warship and an U.S. Navy vessel. That could create problems for shipping vessels, they said.

But Priddy said there has been no impact on Red Sea trade. No tankers had adjusted their routes to his knowledge, and Somali pirates tend to be their primary concern in those waters, he said.

The scale of Iran's weapons transfers, funding and training in Yemen is open for debate, but the White House has perhaps mischaracterized or misunderstood Iran's goals in the Yemen, according to Alex Vatanka, an Iranian senior fellow at the Middle East Institute.

Tehran does not so much see a Houthi victory in Yemen as an end goal, he said. Instead it views the ongoing conflict as a way to drain Saudi Arabia's energy following Riyadh's expensive intervention in 2015 after Yemen's pro-Saudi government fell.

Vatanka said the Iranian regime's view is, "If that's Saudi Arabia's Vietnam ... then let the Saudis dig their own grave."

"Iran right now is playing the Yemen card as part of a larger geopolitical rivalry with Saudi Arabia," he said.

Missed opportunity

The Trump administration may have miscalculated in one other key way, Vatanka said.

By firing the warning shot shortly after ordering a temporary ban on immigration from Iran, along with six other majority-Muslim nations, Trump is allowing the Iranian regime to push the narrative that the United States is not just opposed to Iranian policy, but fundamentally anti-Iranian.

"That was not thought through carefully. This moment, with the missile, is actually an opportunity for the Trump administration to come out and say, 'We're not against the people, we're against the policies of the regime that happens to rule Iran today,'" he said, referring to Iran's latest ballistic missile test earlier this week.

Criticizing the missile test more thoughtfully would have been effective because the average Iranian does not support Iranian policy, in Vatanka's view. They are frustrated that the government is spending money to conduct missile tests while economic and social needs are not being met.

Following a devastating high-rise fire in Tehran, Vatanka said Iranians were passing around a wry observation on social media: We have missiles that can reach Israel, but not ladders that can extend past 10 stories.

"The biggest asset for any U.S. president in putting pressure on the Iranian regime is the people of Iran," he said.