Geopolitical uncertainty will likely create short-term volatility, but we believe fundamental, long-term analysis can provide clarity through these events.
What happened?
Following the June 13 launch of Israel’s air campaign striking nuclear facilities and command centers across Iran, the United States conducted surprise airstrikes on three Iranian nuclear sites over the weekend. While U.S. officials have signaled that these attacks are intended to be limited in scope, strategic escalation by the United States — and Iran’s vowed retaliation — marked a pivotal moment in the Israel-Iran conflict, increasing geopolitical uncertainty and inspiring further concerns about the risk of Middle East oil supply disruptions. The ceasefire announced Monday, June 23rd reduces the tensions and minimizes the risks of escalation.
How have markets reacted so far?
Crude oil prices first surged due to escalating conflict between Israel and Iran, with the initial missile exchanges pushing prices up by over $10/barrel. However, prices fell by 6% late Monday (June 23) after Iran’s retaliatory strike on a U.S. base in Qatar was interpreted as symbolic and carefully coordinated to avoid escalation.
As we wrote earlier this year, we have expected heightened geopolitical uncertainty across the globe. These events, including this most recent conflict, will likely create short-term volatility, but we believe fundamental, long-term analysis can provide clarity through these events, though there is continued risk that events escalate.
What was your outlook for the price of oil prior to the Israeli and U.S. strikes? Has your view changed in light of recent events?
From a supply/demand perspective, we expected an oil market surplus to develop in the back half of the year on rising supplies and a weaker demand profile. Prior to Israel’s initial strike on Iran, Brent crude had been trading in the low- to mid-$60s range, which are prices that we believe are more consistent with our fundamental analysis. In our view, a geopolitical risk premium of at least $10/bbl (barrel of crude oil) was already priced into the market in the runup to the U.S. intervention.
Our base case is a period of elevated uncertainty and oil price volatility in the weeks ahead, though the ceasefire should bring some calm to markets, but without a serious escalation of the conflict. We are not anticipating a material disruption of energy exports from the region, and we expect oil prices to realign with fundamentals as risk premia fade over time.
That said, we recognize that the situation is fluid. The ceasefire — as long as it holds — should de-escalate tensions. But much hinges on the Iranian and Israeli responses, as well as any U.S. counter-response. Because Iran’s missile strike on the U.S. air base in Qatar was telegraphed in advance, we believe Iran opted for a symbolic show of force while offering a path toward de-escalation and the ceasefire.
However, should Iran retaliate with strikes against energy infrastructure in the region, which is just one example of possible escalation, oil and related energy exports could experience a reduction in the weeks and months ahead, likely putting additional upward pressure on prices.
Further, we also acknowledge a lower probability (but more extreme) risk case that the conflict results in the closure of the Strait of Hormuz, which would put physical flows from the wider Gulf region at risk. In that case, oil prices above $100/bbl would not be out of the question. However, as things stand currently, there has been more disruption to natural gas than oil supplies following Israel’s targeting of Iranian gas infrastructure and temporary reduction of gas production in Tamar/Leviathan.
Why is the Strait of Hormuz so important to global economic considerations?
The Strait of Hormuz is arguably the world’s most vital shipping lane. It connects the Persian Gulf with the Indian Ocean, and roughly 20% of the world’s oil flows through it daily (as well as gas and petrochemicals). At its narrowest point, it is only around 20 miles wide, and it is flanked by Iran to the north.
If the conflict were to result in a major escalation such that energy exports and/or shipping through the Strait were closed off, oil prices could feasibly surge above $100/bbl, as noted above. The countries that would be affected hold around 95% of OPEC+’s 5.5 MMbd (millions of barrels per day) of spare capacity, according to Capital Economics; as such, OPEC+ may be severely limited in its ability to employ spare capacity to offset upward pressure on oil prices.
What impact could this have on U.S. and global economies?
From an economic perspective, looking ahead, the main risk is a “stagflationary” impulse stemming from Middle East supply disruptions leading to a prolonged period of high and rising energy prices. In the event of a sustained closure of the Strait of Hormuz the drag on global growth and the boost to inflation could be material.
Under such conditions, it would not be surprising to see broader market weakness that could impact most risk assets. History suggests, however, that the market impact of geopolitical events tends to be short-lived.
Prolonged higher energy prices could also put further pressure on the Federal Reserve to resist cutting rates as it battles inflation.
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The opinions and views of this commentary are that of Cohen & Steers and are not necessarily those of Advisors Asset Management.