As the Israel-Hamas conflict unfolds, financial markets have been on high alert, recognizing the significant impact such events can have on the global economy. It’s a well-established principle of geopolitics that sudden surges in oil prices often precede economic recessions, and the volatile nature of crude oil prices is deeply intertwined with developments in the Middle East.
The ongoing war between Israel and Hamas has prompted scenario planners to ponder the critical question on the minds of finance ministers and central bank governors worldwide: How dire could the situation become?
Kristalina Georgieva, the Managing Director of the International Monetary Fund (IMF), recently revealed that her organization’s analysts have been contemplating the previously “unthinkable” in their efforts to prepare for the next significant disruption to the global economy.
This current localized, albeit distressing, conflict in Gaza has historical precedents. An ominous echo of history can be heard as Hamas’s attack aligns with the 50th anniversary of the Yom Kippur war—a joint assault on Israel by Syria and Egypt that ushered in the end of the postwar global economic boom.
In 1973, Israel’s counteroffensive led to an oil embargo imposed by OPEC, resulting in a fourfold surge in crude oil prices. The ramifications included escalating consumer prices and soaring business costs. This period of higher inflation was quickly followed by increased unemployment, coining the term “stagflation” to describe the combination of skyrocketing living costs and economic stagnation.
It is worth noting that OPEC’s influence has waned over the years, and the global economy is no longer as reliant on oil as it once was. Nevertheless, the importance of oil persists, which is why the situation in the Middle East remains under close scrutiny.
Two scenarios are at the forefront of considerations. In the best-case scenario for the global economy, the conflict remains confined to an Israeli ground operation in the Gaza Strip. In this context, oil prices would stabilize around their current level of $93 per barrel, possibly even trending downward. The IMF estimates that a sustained 10% increase in oil prices shaves 0.15 percentage points off global economic growth while adding 0.4 points to inflation in the following year. As of now, the cost of a barrel of crude oil on the world’s commodity markets stands about 10% higher than it was before the Hamas attack.
The second scenario, far graver, envisions a broader regional conflict commencing with clashes on Israel’s northern border involving Iranian-backed Hezbollah forces in Lebanon. This might eventually draw Iran into the fray. The presence of US carrier groups in the eastern Mediterranean hints at Washington’s preparations for such a scenario.
Economist Nicholas Farr of Capital Economics suggests that if Iranian-backed Hezbollah engages in missile exchanges with Israel from Lebanon, it could open a new front in the conflict. Iran’s involvement could disrupt energy supplies, leading to a surge in oil prices, and may also affect natural gas prices if liquefied natural gas (LNG) exports are disrupted.
Moreover, economist and crossbench peer Meghnad Desai, writing for the OMFIF think tank, foresees a grimmer outcome. He envisions a broader regional conflict involving Lebanon, Egypt, Syria, and other Arab states, potentially driving the oil price toward $150 per barrel. This would result in double-digit inflation in the US and Europe, potentially triggering global recession and prompting central banks to cut interest rates and initiate quantitative easing programs.
For oil to reach $150 a barrel, it would require a significant interruption in the global supply of crude, possibly due to the closure of the Strait of Hormuz, through which nearly 20% of the world’s daily oil supply flows. Geopolitical risk premiums, as seen in recent days, tend to be transient unless actual supply disruptions materialize.
Amidst this uncertainty, Saudi Arabia, the world’s largest oil exporter and a linchpin of OPEC, faces a delicate balancing act. While it has an interest in maintaining crude oil prices at a high level, it must avoid pushing them so high that it triggers a severe global recession, causing oil prices to plummet. Riyadh is expected to face pressure, both from Washington and other global actors, to ensure a steady flow of oil.
Finally, there is a doomsday scenario, as envisioned by historian Niall Ferguson. In this nightmarish scenario, China exploits the crisis to impose a blockade on Taiwan, potentially escalating the regional Middle Eastern conflict into a third world war. Even if fought conventionally, a military conflict between the world’s two largest economies would disrupt global supply chains, erode confidence, and crash asset prices. The catastrophic economic consequences could rival a second Great Depression.
As the Israel-Hamas conflict continues to unfold, the global community remains vigilant, cognizant of the significant implications it holds for oil prices and the broader global economy.