How a Middle East conflict could hit commodities markets

Singapore

SURGING oil and gas prices, skyrocketing insurance costs and attacks on energy and banking infrastructure are likely to be some of the initial impacts if the current Iranian tension erupts into outright war.

A lengthy conflict in the Persian Gulf could tip the US and global economies into recession and even accelerate the worldwide move away from fossil fuels. Here's what some top oil, commodity and geopolitical analysts see as the most likely outcomes.

Will the Strait of Hormuz be shut down?

In a limited confrontation, the flow of oil and other commodities should continue through the strait, with the caveat that certain oil tankers could be targeted by Iran, said Ian Bremmer, president and founder of Eurasia Group, a political risk research and consulting firm. In a major war, Iran could shut the strait and lay mines.

A concerted effort will be made to keep the strait open, and before any military strike begins, a plan to protect ships will have been worked out with other regional countries, such as Saudi Arabia, said Ole Sloth Hansen, head of commodity strategy at Saxo Bank A/S. Insurance costs will skyrocket, or there will be no cover at all, and shipowners with no cover may be reluctant to risk their ships.

The idea that the Strait of Hormuz would close is "nonsense", said Fereidun Fesharaki, chairman of energy industry consultant FGE and an adviser to Iran's government in the 1970s. If a ship is sunk in the strait, it might close for a couple of weeks, but then traffic will resume. If the Iranians try and shoot everything that passes, then the British, French and everyone will get involved. "The Iranians know if they do that, they will lose big, although their proxies could put mines in the strait."

How would oil and gas prices react?

Oil could jump to US$100 a barrel or higher immediately after a war breaks out, but would likely settle closer to US$80 once some resilience of exports from the region is demonstrated, said Ken Medlock, a senior director at Rice University's Center for Energy Studies in Houston. While the rise of US shale might mute the impact a bit, it can't offset any major disruption in the Middle East.

Crude could spike towards US$90 a barrel before eventually collapsing amid the negative impact on global demand, Mr Hansen said. The level it reaches will depend on the ability to maintain safe passage through the Strait of Hormuz.

In the case of a full regional conflict, oil will rise past US$100 a barrel and could even go to US$150, Mr Bremmer said. If there are only limited strikes, oil might reset at around US$80.

Liquefied natural gas (LNG) prices may rise more than oil prices due to the fact that a greater proportion of global flows pass through the Strait of Hormuz than for oil. "Whatever the spike you get in oil, you will likely get twice the spike in spot LNG," David Hewitt, an oil and gas analyst at Macquarie Capital Ltd, said in June.

The market is largely discounting the chance of war at the moment, Mr Fesharaki said. If there's a major attack and reprisals, Brent could go to US$90 to US$100 a barrel. LNG would be impacted as well, but the market is oversupplied and is dominated by Qatar, which has good relations with Iran, so it's unlikely to be targeted by Tehran.

How vulnerable is Middle East energy infrastructure?

Abu Dhabi in the United Arab Emirates (UAE) is most vulnerable to a conflict because its oil installations are in a small area, unlike in Saudi Arabia where they are very spread out, Mr Fesharaki said. "Their fields are close by, the offshore ones can be hit immediately. Once they throw a few missiles, foreign companies will evacuate, and if they don't have foreign workers, they can't produce the oil." There would likely be an increase in Iranian cyberattacks on energy and banking targets in Saudi Arabia and the UAE, Mr Bremmer said.

What will be some of the indirect impact of a prolonged conflict?

Japan, India and South Korea would be some of the most vulnerable economies to a Persian Gulf war due to their heavy dependence on the region's crude. India imports more than 80 per cent of its oil and around two-thirds of that comes from the Middle East. Every 10 per cent increase in the price of a barrel of crude widens the nation's current-account deficit by about 0.4 per cent of gross domestic product, Sonal Varma, chief India economist at Nomura Holdings Inc, said in June.

Higher oil prices will push the US and global economies towards a recession, Mr Hansen said. Industrial metals will take a hit from the economic downturn and gold should move higher despite a stronger dollar. The current global move away from fossil fuels would also be intensified.

A Middle East war could accelerate the move away from oil as it would remind people they are reliant on a dangerous place, Mr Fesharaki said. "Oil is dying by itself over the next 10-15 years, this would just be a kick in the butt." BLOOMBERG