Investors weigh knock-on effects of Iran conflict

Oil and gas prices continued to climb this week following tit-for-tat strikes against Gulf energy infrastructure as the conflict in Iran showed no signs of easing up.

On Wednesday, Iran struck Qatar’s Ras Laffan gas plant, the world’s largest, causing extensive damage. The attack followed an Israeli strike against Iran’s South Pars gas field and the closure of the UAE's Habshan gas facility and Bab oil field following retaliatory Iranian strikes. In response, Brent crude — a proxy for global oil prices — climbed nearly 7% to US $114 a barrel on Thursday, while European wholesale gas prices surged 35% at market’s open, to their highest level since the start of the conflict.

Investor fears about a prolonged conflict have driven equity markets marginally lower, with Europe’s Stoxx 600 Index falling close to 2% on the week by Thursday afternoon. The Nikkei 225 fell near 1% over the same period, while the S&P 500 dropped to around 2%. Yields on US, German and UK government debt all climbed.

Mark Sherlock, Head of US and Sustainable Equities, says that higher oil prices will have a ripple effect across the global economy. “The costs will feed through into any number of goods, most obviously petrol at the pump but also into the price associated with anything that needs transporting,” he says. “This then puts pressure on inflation, which then puts pressure on interest rates, which — all other things being equal — will act as a contractionary force for the global economy.”

With this in mind, the key question for investors now is how long the conflict might go on, says Sherlock. “There aren’t really that many credible options to get oil out of that part of the world other than through the Strait of Hormuz,” he says. “If the conflict lasts a couple of weeks that is probably tolerable; if the Strait remains closed for months then it becomes much more problematic for global stock markets and the equities we invest in on behalf of our clients.”

The commodities cost

Damian McIntyre, Head of the Multi-Asset Solutions Team, highlights a similar theme, noting how the second-order effects of the higher oil price and the closure of the Strait of Hormuz are now becoming apparent as the cost of other commodities begins to rise. 

As just one example, McIntyre notes how Qatar accounts for about 30% of the world’s helium output as a byproduct of liquified natural gas (LNG) processing. 

“But it’s other areas too,” says McIntyre. “The price of urea – a crucial component of agricultural fertilizers – has surged. So has the price of plastics feedstocks in the form of Polypropylene and polyethylene. All three are derivatives of oil and natural gas production and processing, so it is not surprising they have been affected.”

But even other areas — aluminum for instance — have been hit, according to McIntyre. “Again, this shouldn’t be a surprise,” he says. “Gulf producers account for about 9% of global aluminum output so, of course, the closure of the Strait of Hormuz will make a difference.”

The fixed-income view

Mitch Reznick, Group Head of Fixed Income – London, notes that Thursday’s unanimous decision by the Bank of England to hold interest rates at 3.75% shows just how quickly inflation expectations have shifted since the start of the Iran conflict. “The Monetary Policy Committee's (MPC) use of past tense in the release when referring to disinflation formalized the pivot toward reflation, which explains its strong language of vigilance,” he says. 

“The material sell‑off in sterling rates over the last three weeks shows that the market had anticipated this to some degree; however, the tone of the release pushed rates even wider. By way of example, at the start of the month the market was pricing a 90% chance of a rate cut. That had fallen to zero a few days ago, and now the market shows a 65% probability that the MPC will vote to increase rates in April and again in June.”