Israel-Hamas War Escalation, the 2nd Oil Crisis and Global Economic Impact: What to Expect

Palestinians, who were forced to leave their homes due to Israeli airstrikes, are seen receiving food supplies from volunteers at a United Nations-operated school in Rafah, southern Gaza Strip, on May 23./AFP-Yonhap

The global economy, which has started to show resilience from the health crisis and supply chain problems caused by the COVID-19 pandemic, is now facing a new crisis dubbed as ‘two wars.’

◇ COVID-19 pandemic, Ukraine war, Israel-Hamas war, and the global economy

If the war between Israel and Hamas escalates, it could potentially lower the growth rate of the already struggling global economy, which has been affected by the COVID-19 pandemic that has persisted since 2020, global supply chain issues due to Russia’s invasion of Ukraine since February 2022, and the impact of record inflation. According to a report by the New York Times (NYT), it could also trigger a rise in energy and food prices.

World Bank (WB) President Ajei Banga warned in last month’s International Monetary Fund (IMF) and World Bank Annual Meeting in Marrakech, Morocco, and the annual Future Investment Initiative (FII) forum in Riyadh, Saudi Arabia, that the Israel-Hamas war could have a severe impact on the global economy, which has barely found a path to soft landing.

Palestinians are seen walking through the completely destroyed Tel al-Hawa area of Gaza City on May 30, following an Israeli airstrike./EPA-Yonhap

◇ The escalation of the Israel-Hamas war and energy prices

There is growing concern that if the ‘axis of resistance,’ including Iran and its Sunni-majority sponsor, Lebanon’s Hezbollah, Gaza’s Islamic Jihad, and Shia armed groups in Iraq, Syria, Yemen, etc., join the war between Israel and Hamas, the outbreak of the Fifth Middle East War could result in the Second Oil Shock, causing severe damage to the global economy.

The WB warned that if the war between Israel and Hamas expands while the Ukraine war continues, the prices of oil and other raw materials could skyrocket.

Indirmit Gill, WB’s Chief Economist, predicted, “The recent conflict in the Middle East follows the greatest shock to the raw material market since the 1970s, which is the war in Ukraine by Russia. If the conflict spreads, the global economy will face a double energy shock for the first time in decades.”

Although the international oil price increase rate has remained relatively stable at around 6% since the start of this ‘war,’ the WB has predicted that if the war unfolds according to the worst-case scenario, similar to the First Oil Shock, the world’s oil supply could decrease by 6-8 million barrels per day, and oil prices could reach $140-157 per barrel.

Pierre Olivier Gourinchas, IMF’s Chief Economist, predicted that if international oil prices rise by 10%, global economic production could decrease by 0.15 percentage points, and inflation could increase by 0.4 percentage points.

In October 1973, during the Fourth Middle East War (Yom Kippur War), six countries of the Organization of Petroleum Exporting Countries (OPEC), including Saudi Arabia, raised the price of crude oil from $3.01 per barrel to $5.11 to support the Arab alliance army, led by Egypt and Syria. In January of the following year, they raised the price again to $11.65. As a result, almost all primary commodity prices increased, causing severe inflation in various countries. This led to severe stagflation in the United States and a low-growth era in high-growth countries.

Israeli Prime Minister Benjamin Netanyahu (left) is seen hugging U.S. President Joe Biden upon his arrival at Ben Gurion Airport in Tel Aviv on May 18./AP-Yonhap

◇ Worst-case scenario of the outbreak of the Fifth Middle East War

Gideon Rachman, a senior columnist for the Financial Times (FT), predicted that if Hezbollah, the strongest Shia militia supported by Iran, attacks the Israeli military with precision-guided missiles, the Israeli military will directly attack Hezbollah as warned by Prime Minister Benjamin Netanyahu, which could lead to the Islamic Revolutionary Guard Corps (IRGC) of Iran joining the war, resulting in the escalation of the conflict.

In addition, Rachman suggested that if Iran and its sponsored militias attack U.S. military forces and facilities in Bahrain, the United Arab Emirates (UAE), Qatar, Syria, Iraq, etc., it would lead to U.S. retaliation, and if the U.S. Navy resumes navigation in the Strait of Hormuz, a major world oil passage, and Iran blocks the strait by laying underwater mines, it could cause a significant disruption in Saudi Arabia’s oil exports and throw the global economy into chaos.

Rachman also suggested that the Houthi rebels in Yemen, a Shia group, could potentially launch precision-guided missile attacks on desalination plants in Riyadh, Saudi Arabia.

U.S. Secretary of State Tony Blinken is seen meeting with Saudi Foreign Minister Faisal bin Farhan at the Saudi Foreign Ministry in Riyadh on May 14./Reuters-Yonhap

◇ The U.S. and Iran share interests in preventing the escalation of the Israel-Hamas war

However, experts believe that the likelihood of Iran and Hezbollah directly participating in this war is low, and the reason is economic. Iranians are opposing involvement in the war as they are facing financial problems such as increasing unemployment due to U.S. economic sanctions, according to Newsweek.

Reuters reported that Hezbollah is well aware of the crisis in Lebanon, its base, where the economy has collapsed after a financial situation four years ago, and is unlikely to join the war. A source familiar with Hezbollah said that neither Hezbollah nor the Lebanese government wants a war, and a Lebanese politician said that if Hezbollah wanted a war, it would have joined Hamas’ surprise attack on Israel on October 7.

Lebanon suffered significant damage from the 2006 war, which broke out when Hezbollah kidnapped two Israeli soldiers, and it took years to recover from the war. After the war, Hezbollah leader Sayyid Hassan Nasrallah confessed that he “did not anticipate the war” and “would not have executed the operation if he knew it would lead to a conflict,” according to Reuters.

Jason Bordoff, director of the Global Energy Policy Center at Columbia University in the U.S., said that while the situation is “extremely unstable, uncertain, and scary,” most, including the U.S. and Iran, believe that escalation is not in anyone’s interest.

The Israeli military is seen launching artillery shells near the border with the Palestinian Gaza Strip in southern Israel on May 11./AFP-Yonhap

◇ Outbreak of the Fifth Middle East War and the Second Oil Shock

Analysts are gaining confidence that global economic chaos like the Second Oil Shock will not occur even if the’ war’ expands.

Newsweek analyzed that the current situation differs from the First Oil Shock, as the dollar is overwhelmingly stronger than in 1973, making it difficult for severe dollar weakness and inflation.

After then-U.S. President Richard Nixon declared a halt to the gold-dollar exchange in 1971, the dollar continued to weaken, which was one of the reasons why oil-producing countries, fearing a decline in asset values, raised oil prices.

However, the dollar is currently strong, and if the Middle East situation worsens, the possibility of buying dollars is greater, so global inflation due to rising oil prices will not cause the same level of chaos in the global financial system and the market as in the early 1970s, according to Newsweek.