The Strategist

Escalation in the Middle East: The impact on the oil sector and inflation

The escalation of the conflict in the Middle East, with Iran launching another rocket attack on Israel followed by Israel's promise of retaliation against Iran, is reflected in increased nervousness in the oil price and in the volatility of energy stocks. The price of Brent crude oil rose by almost 12% in a very short period of time due to concerns about supply being affected. Indications suggest that speculative positions in the oil market have reached a new two-year high. Over the same period, the global energy sector rose by almost 7%, making it temporarily the strongest global sector, although it still lagged behind the global equities index in year-on-year terms. How should the situation be assessed?

Date
Author
Georg Ruzicka, Head Equity Research LGT Private Banking, Dr. Wolfgang von Hessling, Chief Economist Private Banking Europe
Reading time
10 minutes

Öl
© Shutterstock

Iran produces an estimated 3 million barrels of oil per day, around 3% of the world's daily production. Of this, 1.7 million barrels are exported, currently close to a six-year high. Iran's Kharg Island in the Persian Gulf is the main export terminal for around 90% of Iran's oil destined for export. The island has extensive infrastructure for the storage and transshipment of oil. There are large storage tanks, loading facilities and pipelines that transport the oil from the mainland fields to the island. During the Iran-Iraq War in the 1980s, the island was a frequent target of Iraqi attacks, which is why the Iranian Navy maintains a base there to protect the island. A direct Israeli strike against this infrastructure or the oil tankers in Kharg would cause considerable nervousness in the energy market, as this would harbour further escalation potential and directly affect Iran's export capacity. As a result of the ongoing international sanctions, Iran supplies countries that are less susceptible to pressure from the US, such as China, Syria, Venezuela and India. If Iran's supplies to these countries were to be disrupted, they would have to cover their oil imports from other sources, with the increased demand contributing to global price pressure. By contrast, targeted attacks against, for example, Iranian refineries domestically would primarily affect Iran's supply to the domestic market, with relatively little global impact, at least in the short term.

Global oil supply stable, despite risks

There are also concerns that Iran could be prepared to disrupt production and transport activities in other regions - such as the Strait of Hormuz, through which an estimated 20% of the world's oil trade passes - in order to internationalise possible war costs using higher oil prices. However, such a move would put the recently improved diplomatic relations with Saudi Arabia to the test, which hardly seems in Iran's interest. It should also be noted that OPEC+ has an estimated 6 million barrels of unused production capacity after the organisation restricted its output. Recently, concerns have been raised that Saudi Arabia could abandon its target of an oil price of USD 100 and expand oil production again, which would likely weigh on the oil price. Oil futures also appear to be pricing in a similar scenario, with higher oil prices in the short term than in the longer term. Overall, the global supply of crude oil does not appear to be under any particular threat at present, although there are clear risks for the global oil market. We have rated the energy sector as “Overweight”, partly as a hedge against geopolitical risks such as an escalation in the Middle East.

The potential for rising inflationary pressure

The development of inflation momentum is usually strongly influenced by local conditions (e.g. scarcity or oversupply) in regional submarkets (e.g. for food) and local wage pressure. Nevertheless, energy prices play an important role in explaining overall inflation, especially for internationally well-connected economies. An analysis of the relationship between monthly oil price changes and the development of annual inflation rates clearly shows that a rise in oil prices is reflected in rising inflationary pressure. For example, looking at the period since the turn of the millennium, a USD 10 increase in the US crude oil price within a month caused the annual rate of consumer price inflation to rise by more than 55 basis points over the following quarter. Similar behaviour can be observed in the energy-importing eurozone, which emphasises the benchmark function of international oil prices for determining the influence of energy costs. In general, therefore, it can be assumed that disruptions in the supply of oil due to the Middle East conflict could initially lead to a “resurgence” of inflationary pressure. However, in our view, such developments should be rather limited in terms of duration and magnitude due to the dampening effects on the demand and growth outlook, as well as the greater independence of the US with regard to crude oil imports.

LGT Navigator China’s stimulus-driven stock rally comes to a halt All articles LGT Navigator US tech stocks drive market gains
Contact us
Forward-looking for generations
Our newsletters - automatically up to date

The LGT newsletters provide you with regular information on insights and news from the fields of business, finance and much more.

Newsletter registration
Follow us
Scaling impact LGT Venture Philanthropy