· Tension in the region due to Hamas’s unexpected strike on Israel
is causing Oil prices to spike.
· Ripple effect could be higher future inflation expectations &
lower equity valuations.
The importance of the Middle East for the world is quite significant, as a
third of the globe’s oil production comes from that region.
Following the Hamas surprise strike on Israel over the weekend, the death
toll on both sides climbed in the low thousands. The US said it is sending
warships to the region as the conflict is heading into a 4 th
day, causing oil prices to reverse their recent decline as
war-risk premium
grips the market.
In late September, Brent was on track to hit the $100 a barrel mark as cuts
from powerhouses Saudi Arabia and Russia created a tighter oil market.
However, the climb abruptly reversed last week, with prices suffering a
steep decline, sparked by fears over weakening demand and markets bracing
for a prolonged period of higher interest rates.
El-Erian says,
« If this expands and brings in other parties, the outlook is for an
even weaker global economy and more inflationary pressure. The markets
are going to find it harder to deal with that. »
The heightened geopolitical risk might quickly escalate if Israel blames
Iran, as the latter is a major oil producer and supporter of Hamas. Any
retaliation against Tehran may endanger the passage of vessels through the
Strait of Hormuz, a vital conduit Iran has previously threatened to close.
The strait, which is between Oman and Iran, is considered the world’s most
important oil transit chokepoint, and more importantly, 40% of world
exports go through the Strait of Hormuz; hence, a conflict between the two
parties can easily lead to a meaningful jump in oil prices.
The last time a major conflict between Israel and the Arab states occurred,
in the 1970s Oil Crisis, saw the benchmark WTI oil price shoot up around 3x
– from about $3 per barrel (pb) to around $10 pb.
In today’s world, if you extrapolate a similar move, that will translate
into oil tripling to over $250 a barrel, which is quite unlikely but will
send inflation soaring through the roof.
Lately, there were two consecutive positive inflation prints on the US CPI,
showing inflation climbing higher once again on the back of oil prices
climbing nearly 40% since June.
Israel might not be a significant player in the worldwide oil supply.
Nevertheless, the conflict might put Iran and the USA at odds. Iran has
emerged as a critical supplier of additional crude oil, helping to ease
markets that were becoming constrained due to supply cuts from Saudi Arabia
and Russia. Any US sanctions on Tehran might limit those deliveries, which
has the potential to cause oil markets to keep rising.
Equities have been holding for now, but any geopolitical escalation will
put downward pressure on them.
Investors who want to bet that oil prices are rising might consider our
2x WTI Oil
and/or
3x Oil & Gas
.
Alternatively, those who bet on them declining could go for our
-2x WTI Oil
and/or
-3x Oil & Gas
.
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