Events appear to be spinning out of control in the Middle East, and the threat a Saudi-Iranian war is looking increasingly credible. Make no mistake, an out and out conflict between the two nations would be an unmitigated disaster for the region and the world.
Last week, Houthi rebels in Yemen launched a missile targeting a Saudi airport near Riyadh. The missile was intercepted, but a Saudi-led military coalition battling the Yemeni rebels called the attack a "blatant military aggression by the Iranian regime which may amount to an act of war." The Saudis reserved the "right to respond", according to the official Saudi Press Agency.
The major OPEC oil producers, all abutting the Persian Gulf, export almost 20 percent of the world's oil supply through the Strait of Hormuz, which connects the Persian Gulf to global markets. The strait, a mere 34 miles wide at its narrowest, sits pinched between Iran to the north and Oman to the south. Were a war between Saudi Arabia and Iran to erupt, this chokepoint could easily be closed.
Indeed, shipping could stop even before a single ship is damaged. If insurers perceive an imminent risk of attack on a tanker in the region, they would either suspend insurance or charge exorbitant rates for coverage. Under the circumstances, vessel owners could opt to wait out the hostilities rather than risk their tankers.
"The current U.S. administration has not shied from using inflammatory rhetoric and exploring novel approaches to Middle East diplomacy. Now is not that time for that. The U.S. must act as the global policeman, as it has since World War II."
Of course, the strait could also be closed as a direct result of military hostilities, for example, by Iran.
The impact of such a closure on the global economy would be severe and immediate. For example, the Suez Crisis of 1957 saw 10 percent of the world's oil production taken off the market. Within a month, the U.S. and Europe were facing a recession which would last the better part of a year.
In 1973, the Arab-Israeli War and resulting Arab OPEC embargo would bring long lines to gas stations as the oil price quadrupled. On an annual basis, global oil production held steady, but Persian Gulf exports to the U.S. fell by 1.2 million barrels / day, or about 7 percent of total U.S. consumption. This oil shock would plunge the U.S. into a recession which lasted for two years.
In the event of a Saudi-Iranian hostilities lead to a sustained outage of Persian Gulf exports, a severe and prompt global recession will follow similarly.
Much as in 1973, U.S. imports from the Persian Gulf still amount to 8 percent of consumption, the loss of which was sufficient to knock 10 percent from GDP from 1973 to 1975. However, China and other importers would seek to outbid the U.S. on its imports from countries like Nigeria, Angola and even Brazil and Columbia. In all, U.S. imports could fall by 15 percent of total consumption--twice the drop from 1957 to 1973 and sufficient to plunge the U.S. into a deep recession lasting years.
On the other hand, U.S. import dependence has fallen dramatically since the start of the shale revolution. Even as the U.S. coastal regions would suffer from high oil prices, boom times would return to Louisiana, Texas and on up to North Dakota and Canada's Alberta province. A loss of 20 percent of the world's oil supply would push oil prices into the $200 / barrel range. The shale sector would see its glory days.
Those countries without material oil production would suffer the most, notably Europe and East Asia, in particular Japan and South Korea.
China's situation would be dire. In the last few years, Chinese import dependence has become acute. Oil imports cover more than three-quarters of total Chinese consumption, and half of China's imports originate in the Persian Gulf.
The closure of the Strait of Hormuz would not only put China into recession, but given the high degree of financialization of the economy, could create a wider societal and political crisis. The reaction of the Chinese government is difficult to anticipate, but China would certainly bring maximal pressure on the U.S. and Persian Gulf countries to end the conflict, by whatever means. The ultimate takeaway for China would be the necessity to build, at all speed, a global military and diplomatic presence capable of projecting force to influence events in the Middle East and, if necessary, to displace the U.S. in the region.
Finally, given the history of cooperation between North Korea and Iran on missile programs, the threat of missile strikes from Iran could exacerbate tensions between the U.S. and North Korea. Preventing Iran from obtaining a nuclear weapon could become the absolute priority in the conflict and lead to a rapid escalation of the crisis on the Korean Peninsula.
For investors, the best hedge, if events can be reasonably hedged at all, would be long positions in oil futures, U.S. shale operators and land drillers, and western hemisphere operators like Canadian oil sands producer Suncor and Brazilian oil major Petrobras.
However, hedging is no substitute for conflict mediation. The current U.S. administration has not shied from using inflammatory rhetoric and exploring novel approaches to Middle East diplomacy. Now is not that time for that. The U.S. must act as the global policeman, as it has since World War II. The country must calm tensions in the Middle East and reassert U.S. commitment to a fair and principled diplomacy which seeks to resolve conflicts through negotiation, not reckless force. If the U.S. fails to do so, the result will be an unmitigated disaster, not only for the region, but for all of us.
Commentary by Steven Kopits, managing director, Princeton Energy Advisors.
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