Iran's response to Israel will be a choice between vengeance and endurance. Market indicators suggest it's opting for survival.

• The leaders of Iran, including Ayatollah Ali Khamenei, have vowed revenge, but their behavior and words suggest a more restrained approach.
• A war between Israel and Iran would have devastating consequences for the entire region, with Iran being particularly affected due to its already struggling economy and vulnerable oil facilities.
• One regional analyst told CNBC that Israel's recent attacks on Hezbollah have effectively dismantled the key component of Iran's regional proxy network.

The powerful proxy network of Iran in the Middle East is being hit by Israel, which has intensified the conflict with the Lebanese militia group Hezbollah and on Friday assassinated its long-time leader, Hassan Nasrallah, in a series of airstrikes on Beirut.

Since its establishment in 1982, Hezbollah has been Iran's primary strategic ally, functioning as both a military and political organization. Tehran has consistently funded and supported Hezbollah's growth, making it the world's most heavily-armed non-state group.

Since the beginning of September, Israel has progressed from disabling large portions of Hezbollah's communication systems to assassinating its top leader and several other senior commanders.

Iran's leaders have vowed revenge, but their actions and words suggest a more restrained approach so far. A full-scale war between Israel and Iran would have disastrous consequences for the entire region, particularly for Iran, whose economy is already struggling and whose oil facilities could be easily targeted.

Despite threats to supply, oil prices remain near $70 a barrel for international benchmark Brent crude, indicating markets anticipate a moderate reaction from Iran, one of OPEC's largest oil producers.

According to Behnam ben Taleblu, a senior fellow at the Foundation for Defense of Democracies, Israel's recent attacks on Hezbollah have effectively dismantled the key component of Iran's regional proxy network.

"The Islamic Republic's involvement in the conflict will put a direct target on its back, making survival the top priority over revenge in a war of attrition."

Following the assassination of Ismail Haniyeh in Tehran, Khamenei vowed a "blood for blood" response. However, after Nasrallah's killing, the tone was different, with Khamenei stating that it would be up to Hezbollah to decide its response.

""Hezbollah will lead the Resistance forces in the region, and their fate will be determined together," Khamenei stated on the X social media platform on Saturday."

'Iran has shown restraint'

Iran's economy has been severely impacted by years of western sanctions, mismanagement, and corruption. High inflation has eroded the purchasing power of Iranians, making it difficult to afford basic necessities. The country's currency, the Iranian rial, has depreciated severely, further exacerbating the economic crisis. With a population of nearly 90 million, Iran is not in a position to afford a war, according to regional analysts.

Masoud Pezeshkian, Iran's newly-elected president, expressed his determination to improve relations with the West and rekindle negotiations on the JCPOA, which could potentially ease sanctions on Tehran in exchange for limitations on its nuclear program.

Pezeshkian, often viewed as a reformist, is reportedly advocating for caution in response to Israel's ongoing attacks on Hezbollah and Yemen's Houthi militants, who are backed by Tehran and have been attacking Israel and Israeli-linked vessels in the Red Sea.

"Although Iran has made promises of retaliation through rhetoric, it has practiced restraint, even as Israel has intensified its actions, according to Sina Toossi, a senior nonresident fellow at the Center for International Policy. Many reformist elements within the Pezeshkian administration believe that Iran cannot afford a war that puts its vital infrastructure at risk."

Some hardline officials in Iran's government believe a strong reaction is necessary to deter Israel from attacking their nuclear sites, as they fear Tehran could be the next target.

Toossi stated that Iran's priority is to maintain its regional influence and continue attrition warfare against Israel without causing a broader confrontation that could destabilize its alliances in Lebanon, Iraq, Syria, and Yemen, or result in strikes against Iran itself.

On Monday, Israeli Defense Minister Yoav Gallant hinted at a possible ground invasion of Lebanon in the near future. The impact on Iran's strategy is uncertain.

Regional deterrence 'in shambles now'

Hezbollah announced that it will name its new leader soon and will continue to launch rockets up to 150 kilometers (93 miles) into Israeli territory, stating that its fighters are prepared for a possible Israeli ground invasion. Meanwhile, Israel carried out airstrikes over the weekend, claiming to have hit several targets in Lebanon on Sunday.

Naim Qassem, Hezbollah's deputy chief, stated on Monday that their actions are the bare minimum necessary to win the battle, which may be long. He added that they had won in the 2006 war against Israel and would do so again.

Despite being under pressure, Iran remains committed to backing its regional allies.

According to Ali Vaez, Iran project director at non-profit Crisis Group, Iran is unlikely to confront Hezbollah, but it will support it and attempt to reform its image.

"Iran's regional deterrence is in disarray, but this does not mean that Iran will surrender. Instead, it has no other viable strategic option than to rely on nonstate actors for strategic depth."

Despite not seeing any progress in its efforts to force Hezbollah away from its northern border, Israel continues to push ahead with its tactical victories.

Some oil market participants may disregard this escalation because there has not been a significant physical supply disruption and Iran has not shown any interest in participating in this ongoing conflict, according to Helima Croft, head of global commodity strategy and MENA research at RBC Capital Markets, in a research note published Monday.

"Despite the uncertainty surrounding the regional conflict, it remains unclear whether it is the start of the end or the end of the beginning."