Oil’s war risk premium and the GCC capital markets

In the past two weeks there has been a sentiment shift in the oil futures markets, from the biggest net short position in the Brent contract to a $4 war risk premium in its current $74 price. 

This shift is entirely due to the escalation of the IDF-Hezbollah war in Lebanon and Israel’s public pledge to retaliate against Iran’s October 2 missile attack. 

The Biden White House and the State Department have been unsuccessful in persuading Israel to agree to a ceasefire, and this is the reason why the war premium in oil will remain.

The scale of the violence and precise targets chosen in Israel’s revenge attack on Iran will define the upward move in crude oil, as any hope for a diplomatic resolution of the conflict is now unrealistic.

I even see Brent crude call options with a $100 strike price now being purchased by hedge funds, airlines and refineries to hedge commodity risk on London’s IPE and the Chicago Merc.

If the IDF attacks Kharg Island, the global wet barrel market will lose 1.7 million barrels a day, and if Iran mines the Straits of Hormuz to disrupt Gulf tanker shipping, the US Navy will attack the shore, to strip ballistic missile batteries from the Revolutionary Guards.

For now, the oil market is ignoring bearish fundamental omens, obsessed only with the Sophoclean tragedy that has ignited the Middle East

This scenario, while not highly probable, would easily mean an oil shock and $100 Brent. Investors ignore the Ukraine and Gaza wars, but they can no longer ignore the imminent IDF-Iran war in the heart of the world’s pre-eminent oil province and energy chokepoint.

For now, the oil market is ignoring bearish fundamental omens such as a surge in non-Opec output from North America, Brazil, Guyana and offshore West Africa.

Soft Chinese demand, a recession in Europe and Opec quota cheating are also bearish, but the oil futures markets are only obsessed with the Sophoclean tragedy that has ignited the Middle East.

In the first week of October Saudi Arabia’s Tadawul All Shares Index (Tasi) erased all its 2024 gains, which suggests that investors now place a risk premium on assets in the GCC’s largest economy and highest volume trading stock exchange.

At 20-times earnings, the Saudi Tasi trades at a significant premium to emerging markets. But its valuation multiple could well contract as earnings per share growth slows, US dollar and treasury bond yields rise and a war risk premium is attached to Mena equities.

Wall Street no longer expects a jumbo 50-basis point rate cut at the November meeting of the Federal Open Market Committee (FOMC), the US Federal Reserve’s setter of monetary policy. Raphael Bostic, head of the the Atlanta Fed, has even suggested that the FOMC conclave skip a rate cut next month. 

The US election is also negative for global equities, since a Trump election means higher tariffs and a global trade war while a Harris victory means higher corporate taxes.

The GCC bond and sukuk markets are vulnerable to the 50-basis point rise in both two-year and 10-year US treasury note yields and a negative Eurobond new issue milieu, as fund managers fear committing capital to Mena risk in war time. 

• Oil sinks 4% as potential Iran disruption fears subside

• IEA confident global oil supply can absorb disruption

• The talk is of oil, but gas is most at risk in the Iran-Israel conflict

Regional money markets also face a tighter liquidity environment due to higher government borrowing, a fall in cross-border bank lending to the GCC and a spike in IPO issuance by local companies. 

Long-duration paper issued by lower-rated sovereign credits such as Bahrain and Oman has fallen in price in the past month because of the regional geopolitical outlook, which coincides with a bearish pivot in the US treasury bond market. 

Only Lebanon’s penny eurobonds have surged, up 40 percent in price as Hezbollah’s devastating losses in October suggest its role as political king-maker in Beirut is over and the Lebanese state may well be resurrected by the West/GCC with IMF funding.

It is ironic that the GCC bond and sukuk markets notched their best winning streak in September, caused by euphoria over the jumbo Fed rate cut, even though Brent fell to $70 on oversupply angst.

The bullish psychology has dramatically reversed in October, as the debt markets of the Gulf brace for war even as Brent crude trades at $74 a barrel.

Financial markets hate uncertainty, and nowhere is this truer than the GCC, which has traditionally placed a premium on political, economic and fiscal stability that can no longer be taken for granted if an Israel-Iran war escalates.

Hezbollah’s missile attack on Israel’s Haifa port/military hub and punitive Israeli airstrikes in Syria and Yemen have amplified the geopolitical malaise that has gripped the region.

This will have an impact on insurance premia, freight rates, consumer spending, supply chain inflation, bank credit growth and FDI inflows in the GCC.

A quick, decisive end to the Israel/Iran conflict is essential both for the stability of the Middle East and the global energy market on the eve of the most important presidential election in recent US history.

The ancient Chinese curse, “May you live in interesting times,” has once again come to haunt us in the Gulf.

Matein Khalid is the chief investment officer in the private office of Abdulla Saeed Al Naboodah and the CEO designate of a venture capital firm. He is also an adjunct professor of real estate investing and banking at the American University of Sharjah