Former Intel Operatives Say Middle East Conflict Is Shifting Beyond Oil

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There are plenty of questions being asked about what has gone on in the Middle East. There will be time to figure out how we got here. What went right, what went according to plan and what didn’t go so well. But now is not the time for that, at least not for investors. Now is the time to plan, adapt and ensure the best possible outcome for what you are responsible for.

For context, in my “day job” with Academy Securities, I have the pleasure of working with a group of retired generals, admirals and senior intel operatives. They help me form my take on the Middle East. I do think that their insights gives me an “edge” in assessing the situation.

Let’s start With the Strait of Hormuz

Markets are fixated on what is or isn’t transiting across the Strait of Hormuz.

As far as we “know” the strait is passable. There is no physical obstruction blocking ships from transiting it. This has been accomplished by some ships, presumably those laden with Iranian oil destined for their customers, such as China.

But there are some questions about mines and unmanned/manned surface vessels. There are a lot of questions about potential drone and missile strikes.

The insurance backed by the U.S. International Development Finance Corp. (DFC) has not encouraged ships to transit. I haven’t been able to access the policy itself, but insurance alone is not going to get ships and their crews moving.

There is increasingly chatter about “international” efforts to encourage transit through the strait. It may seem pedantic, but until there is evidence of mining, the strait could be traversed today – and is, in fact, being traversed.

So, we want to distinguish between “closed” and “not safe enough to risk it.” Any evidence of real blockage (i.e., closed) – mines, sunk tankers, etc. — would hit markets very hard.

The Story Is Moving Beyond Oil

Yes, oil gets the most attention, but it is only part of the story.

Increasingly, my conversations are shifting away from oil. Oil is fungible (relatively straightforward to load, unload, ship, etc.). The Saudis have opened their pipeline, shifting about 7 million barrels a day to a port that allows ships to bypass the strait. That is good. Russia has had its sanctions lifted. That's good for oil, though I'm not so sure about for Ukraine or Europe.

Liquefied natural gas (LNG) is less fungible than oil and is likely the first product that causes major disruptions in economies. Diesel, jet fuel and fertilizers aren’t far behind.
Downstream products like plastics may become a problem for supply chains. It is difficult to predict who or what will be hit (like we have seen in previous supply chain shocks), but with plastics in so many products, we may be in for some negative surprises.
Taiwan is dependent on imported LNG and helium (about 50% coming from Qatar), and this is becoming a topic of conversation. When one of the world’s most important countries in terms of making semiconductors enters the conversation, it makes sense to be a little more nervous.
Asia (excluding China) and Europe will be hit first. China has significant stockpiles, refining capacity and has further restricted exports of refined products.
“Force majeure” seems to be the term of the week in Asia outside of China. Europe went from dependence on Russia to dependence on the Middle East. Maybe adopting "production for security" and harnessing your own resources (even if not “carbon efficient”) isn’t a bad stop gap for the next decade or so.
Shutdowns are occurring. When you “shut down” a refinery or chemical processing facility, it is not like flicking a light switch. There is a controlled (and time-consuming) process in both directions. It can take a week or more to resume production at full capacity once the decision to start back up is made. This means that the more facilities that are shutdown, the further we are from “normalizing” quickly.

The 'Catch 22' of Maximum Leverage

One form of “maximum” leverage would be to disrupt Iran’s energy industry, creating enormous economic pressure on the regime.

The risk to that is that almost anything that ramps up pressure on the Iranian economy (and there is already a lot of pressure) will cause oil to trade higher for longer. The worst case would be ramping attacks up, say on Kharg Island energy production, only to find Iran still willing to try and keep the strait closed. Do “we” as a nation have the will to go through with “more pain” for “potential gain”?

For now, we will try to find other avenues to achieve goals, as keeping oil contained is a main goal (though I think we should be worried about LNG, etc., but that doesn’t capture the same headline angst as oil still does).

Tail Risks

If the Houthis start attacks again, disrupting shipping in the Red Sea. Or if Iran splinters into various armed factions, creating more chaos and risk, rather than less.

The longer the “status quo” persists, the worse it is for the global economy and markets.

Bottom Line

Hopefully, by Sunday night or Monday morning, we are watching oil trade down hard and stocks

Bonds are not acting as a good hedge – spending fears (globally) and inflation (globally) are pushing on that. I do not see stagflation as a “steady state,” or even as very plausible in an energy-independent America, but it's too early to fight that chatter.

From a markets standpoint I will not add back equity risk, until clear evidence emerges that a solution to transit in the strait is on the way.