Conflict in the Middle East: From Diplomacy to Destabilization

After a week of Israeli strikes on Iranian nuclear facilities and other targets, the United States entered the conflict on Saturday, using B-2 bombers to hit nuclear sites at Fordow, Natanz, and Isfahan with MOP armor-piercing bombs. The situation is evolving rapidly, and the consequences remain uncertain, requiring continued monitoring by investors. The impact on Iran’s nuclear infrastructure is still being assessed, and Iranian officials may downplay the perceived damage or change their strategic approach.

The initial market reaction to the first Israeli attacks was relatively muted: between June 13 and 20, the MSCI ACWI index fell less than 2%, with interest rates and currencies stable. However, with direct US intervention, fears of further escalation and the effects on energy markets are growing. Markets can interpret this differently: from fears of an economic slowdown – as in the Gulf War – to concerns about higher inflation due to higher oil prices, or even cautious optimism if diplomacy leads to a reduction in Iran's nuclear ambitions, even if that seems far off.

Oil and commodity markets, however, have reacted strongly. Brent crude has risen more than 12% in the past week, with some of its largest daily swings since the early days of the Russia-Ukraine conflict. These moves reflect anxiety over potential disruptions in one of the world’s most crucial energy corridors. With U.S. military action escalating the crisis, investors are building in a risk premium to protect themselves from potential supply shocks.

A key unknown is what happens next and which supplies are most at risk. Iran still exports about 1.5 million barrels a day, mostly to Asia and especially China. Any significant disruption in the Gulf region would have devastating effects on the global economy and financial markets.

Iran has many options for retaliation, either directly or indirectly (via regional allies). The Strait of Hormuz is the most critical point, carrying about 20% of the world’s oil and a significant share of LNG. The US Navy’s presence in Bahrain makes a complete closure unlikely, but limited actions (missiles, mines, cyberattacks, GPS jamming) can still discourage shipping, drive up insurance premiums, and disrupt routes. Recent reports suggest Iranian interference with ship transponders, and maritime authorities have already issued warnings. Most of the crude passing through Hormuz is destined for Asia, especially China, Iran’s key partner. Disrupting these flows would not only damage Iran’s economic interests, but also jeopardize its own shipping, as Iranian tankers outside the Gulf could face retaliation or operational difficulties. This risk is especially high if Iranian leaders, isolated and facing possible regime change, act out of desperation. More likely, Iran will adopt strategies that generate continued uncertainty—such as harassment of ships, sabotage, and cost increases—but not entirely disrupt supply lines.

Whether acting directly or through third parties, such as militias in Iraq and Yemen or groups like the Houthis, Iran maintains a significant ability to threaten vital energy infrastructure. Oil fields, refineries, and export terminals across the Gulf region—including major facilities like the Abqaiq processing plant in Saudi Arabia, the Ras Tanura export terminal, and the Mina al-Ahmadi refinery in Kuwait—are within range of missile attacks, sabotage, or cyber operations. The threat is not theoretical: incidents in recent years, such as the 2019 attacks on oil tankers off Fujairah and the drone and missile strikes on Saudi Aramco’s Abqaiq and Khurais facilities, have demonstrated how even limited actions can remove millions of barrels a day from the global market and disrupt supply chains. In the gas sector, rising European stockpiles and a diversification of LNG imports offer some cushion, but any serious disruption to Qatari LNG flows from facilities like Ras Laffan would have ripple effects around the world, forcing Europe and Asia to compete for available supplies. While Iran’s recent diplomatic rapprochement with Saudi Arabia and the United Arab Emirates may mitigate some risks, it cannot offer complete protection for regional energy assets from potential retaliation by Iranian third-party proxies.

While these immediate threats may drain supply from the market in the short term, the prospect of political upheaval in Iran raises the risk of deeper and more prolonged disruptions. If regime change in Iran becomes part of the solution, history signals caution to energy markets. The removals of Muammar Gaddafi in Libya and Saddam Hussein in Iraq led to dramatic and long-lasting declines in oil production, as instability and a lack of clear leadership kept millions of barrels off the market. The case of Venezuela offers a similar lesson: since the death of Hugo Chávez, political and economic chaos has prevented a return to previous production levels. In particular, supply shocks in the past have been absorbed by strong growth in U.S. shale oil production, a dynamic that is less likely today as the sector is more mature. These historical examples highlight that even if hostilities cease, regime change can lead to prolonged and unpredictable supply disruptions. In the case of Iran, any transition could leave oil production and exports in a state of stalemate until a stable government is established.

Given the multiple threats to regional supply – both from acute attacks and long-term instability risks – OPEC+’s ability to protect the market is crucial. The group has recently managed production to support price stability, including canceling voluntary cuts to balance global supply and encourage compliance among members. However, if Iranian barrels were to fail, the region’s spare capacity could quickly run out. Most of this capacity – currently estimated at 3 to 4 million barrels per day, but likely lower after recent increases – is concentrated in Gulf states, which are also at high risk. As a result, further disruptions in the region could quickly deplete available spare capacity and send prices sharply higher.

Meanwhile, oil demand remains strong. Tariff risks are receding, the summer travel season has begun, and inventories in many areas are below typical levels. Given these supply and demand pressures, governments may take additional measures, such as releasing oil from strategic reserves, to help contain prices. However, such interventions take time to take effect in the market, and traders will likely remain defensive, bracing for more volatility.

In addition to these market and supply concerns, investors must also consider the broader geopolitical risks surrounding Iran’s nuclear program. An additional layer of uncertainty now surrounds Iran’s potential nuclear response. Tehran could seek to minimize the perceived damage to its program, move operations to undeclared sites, or reconsider its commitment to international agreements, including a possible exit from the Non-Proliferation Treaty. Such moves would not only further destabilize the region, but could also prolong the conflict and increase the risk of a broader escalation.

Diplomacy remains an option, and a peaceful resolution would be desirable. However, hope alone is not an investment strategy. Investors must prepare for a world where shocks can come suddenly and from multiple directions. Maintaining a diversified portfolio – especially with allocations to commodities such as gold and energy – remains a prudent approach to managing the ongoing uncertainty.