Why There’s Little Cushion to Absorb an Oil Shock
Beyond the human tragedy unfolding in Israel, we acknowledge the risk of escalation in the region and what it could mean for oil prices. Chief Investment Strategist for EMEA and APAC Wouter Sturkenboom, CFA, analyzes why the potential spread of war could strain an already tight oil market and damage a vulnerable global economy.
- Economic Insights & Trends
- Market & Investment Trends
- Politics
- Markets & Economy
Key Points
What it is
We examine the potential impact to the global economy if the war in Israel and Gaza escalates to a broader Middle East war.
Why it matters
Rising interest rates and slowing growth have produced a fragile global economy and heightened risks for investors.
Where it's going
In our tactical portfolio positioning, we are overweight natural resources and underweight global equities.
Beyond human tragedy unfolding in Israel, we acknowledge the risk of escalation in the region and what it could mean for oil prices. Escalation, in particular involving Iran, could disrupt oil supplies in an already tight global market. We see this more as a risk case than a base case for a tactical asset allocation.
But if the war significantly cuts off oil supply, we worry that a potential price shock could degrade the already fragile global economy and prolong equity market volatility. Let's take a closer look.
The global oil supply has become very tight. Oil companies have cut capital investment and exploration over the past 10 years. And the US has drawn down the strategic petroleum reserve from 650 to 350 million barrels in just over three years. Nearly all excess oil production capacity sits in Saudi Arabia, United Arab Emirates, Iraq, and Kuwait.
While there's potential for incrementally more production from countries such as Guyana and Brazil, at the moment, oil producers outside the Middle East are tapped out. Further, Qatar is among big three exporters of natural gas globally, potentially, further straining an important source of energy if the war escalates.
About 20% of the world's oil and liquefied natural gas flows through the Strait of Hormuz along the coast of Iran making it a potential choke hold for oil if the Strait is blocked because of war.
However, we see few signs of concern to the market over how much disruption the war could cause. only briefly after the attack by Hamas. Instead, all eyes have been on rising long-term yields, with the 10-year treasury yield hitting 5% this month.
Rising interest rates and tighter financial conditions in the Us, Europe, and China have added to investor concern that the global economic outlook is deteriorating. As a result, the equity market decline that started two months ago, has picked up speed with global equities falling roughly 10% from their highs. We think there's a little cushion for the global economy or equities to withstand an energy supply shock.
In our global policy model that guides in our multi-asset portfolios, we felt an overweight position to natural resources because of the lack of investment in new production and attractive valuations. The risks related to the war further support this positioning. With equities, we are underweight globally based on our outlook of a slowdown in the global economy, which an oil shock could accelerate.
Tactical asset allocation shifts portfolio allocations based on near-term market developments, in order to enhance portfolio performance.
Main Point
A Global Risk for Investors
Rising interest rates and tighter financial conditions in the U.S., Europe, and China have added to investor concern that the global economic outlook is deteriorating. This leaves the global economy with little protection against a spike in oil prices, creating risk for investors.
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