Can Iran Israel Conflict Cause Next Recession?

The current fragile global economy is facing many risks – the risk of another erupting euro zone crisis, the risk of a slowdown in China, the risk of slower economic recovery in the United States etc. But no risk is more serious and bigger than that posed by a spike in oil prices. Iran Israel conflict is affecting the global economy. The reason is simply fear of another military conflict which can unsettle the equilibrium of the world economy. This “fear premium” has added at least $25-30 to the Brent crude and is expected to add at least $60-80 if there is a conflict between Iran and US backed Israel. This exorbitant price rise and Iran Israel conflict can cause next recession.

Prodution and Exports in Persian Gulf

Sources: IEA, Bloomberg, Datastream, Erste Group Research

The tension has grown to new heights between Iran & Israel after Israel has threatened to attack nuclear sites of Iran in few weeks or months to come, if Iran doesn’t stop its nuclear program. The imposing economic sanctions on Iran are also adding fuel to fire. In reply, Iran has threatened to close Strait of Hormuz at the mouth of the Gulf, if it is being attacked. Almost 35% of the oil shipped by sea and 20% of global oil production is transported through this channel and the blockade would come with dramatic short-term consequences. China would be particularly hard hit. More than 40% of the Chinese oil imports pass through the Strait of Hormuz. This means that Iranian oil is more important to China than Saudi Arabian oil is to the US.

If Iran manages to maintain a blockade, there will be no exports from Iran too because most of their important tanker terminals are located on the side of the Persian Gulf. Iran is an oil-driven economy and the sale of oil accounts for more than 60% of tax revenue and 80% of export revenue. In fact, Iran’s oil exports have fallen this month by some 300000 barrels per day or 14%, the first sizeable drop in shipments this year.

This overall situation if worsened will create a un-fill able gap in the global supplies with dramatic results. The oil price could sky rocket to all-time-highs and might reach $200. It’s no surprise that oil prices rise and stock markets fall in both scenarios. The shock from soaring oil prices would also undermine the emerging hopes for a global economic recovery, damaging consumer and business confidence and depressing the terms of trade for oil-importing nations. The International Monetary Fund has warned that the world is ill-prepared for a new oil crisis. In a paper prepared for last weekend’s G20 finance ministers’ meeting in Mexico and released on Friday, the IMF said developed countries had run down their emergency stocks while spare capacity in the OPEC countries was no more than average. Asian region which has high dependability on middle-east crude with some economies taking more than 90 per cent of their crude from there will suffer the most. Countries like South Korea, which import petroleum but export refined products would divert more of their output to their own market as they would be principally concerned to secure their own domestic supplies. Exports from countries such as Malaysia and Indonesia could also fall, at least as a short-term response.

But there are some contingency plans also. Saudi Arabia is flexible with regard to its export routes and production capacity. UAE is planning to complete a pipeline with a capacity of 1.5mn barrels/day from Abu Dhabi to the Gulf of Oman by summer. The new pipelines and routes would definitely mitigate the effects on the oil market, but not fully neutralize them. Iraq has already approved the contingency plan to expand its oil export routes by adding capacity from its northern fields and building a pipeline to ship oil from southern fields to Ceyhan in Turkey. But are these plans enough to contain the crude prices? Only time will tell.

Whether Israel will attack Iranian nuclear sites is this year’s one of the most crucial question and it’s a 50-50 situation. But the cascading affects to the buildup of the conflict between Iran and Israel is surely being felt the world economy.

Now it’s your turn…..

Feel free to share your experience and thoughts in the comments area.

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