Conflict Implications
By TRG Advisors on October 13, 2023
Hamas Attacks Israel
As many readers are aware, October 7 marked a sad and frightening day in history as another open conflict war has begun in our world. The attack on Israel is the most significant breach of Israel’s borders since 1973 and has resulted in thousands of deaths.[1] The ambush marks a significant escalation of the long-lasting conflict between the two sides and has engulfed the region in chaos as Israel now defends itself. We keep humanity in our thoughts through this period of instability. The conflict has major implications for the oil market, a situation that is already tight from the Ukraine/Russia conflict.
The Israel-Hamas conflict is having a profound effect on crude oil, energy, and aerospace and defense stocks. Crude oil benchmarks were up around 4% on October 9, while aerospace and defense stocks were up a similar amount because of the conflict. Neither Israel nor Palestine are major oil producing nations. However, the impact on energy involves complex geopolitical relationships between multiple countries in the Middle East, beyond Israel and Palestine.
The Energy Impact Depends on Iran and Broader Escalation
Prior to Hamas’ most recent invasion, Israel and Saudi Arabia were attempting to improve their diplomatic relationship with the help of the United States. Saudi Arabia was on track to potentially recognize Israel as a legitimate state. This recognition would be significant, considering that Saudi Arabia is known to be the most powerful Arab state and recognition of Israel could open a political and economic relationship between the two nations.[2] Any potential deal is now off the table, with one Saudi official stating, “The optics are so bad for us right now…things will be on ice for a while.”[3]
The United States has an interest in the Saudi Arabia-Israel relationship because it provides defense support to both nations. The main swing factor in all of this is the level of Iran’s current and/or future involvement in the conflict. Iran has historically been a foe of both Saudi Arabia and Israel, but earlier this year, on March 10, Saudi Arabia, Iran and China issued a joint statement that declared the resumption of a diplomatic relationship between Iran and Saudi Arabia.[4] This results in Saudi Arabia being less reliant on the United States’ military support considering it has made a resolution with one of the United States’ largest adversaries.
There is mixed information towards the role that Iran played in planning the attacks, but its support is undeniable. Iran has been consistently supportive of Hamas in their shared objective to eradicate Israel and America. Iran strongly supported the attacks, evidenced by official statements and by its parliament members shouting, “Death to Israel.”[5] So far, Israel has not been in any direct conflicts with Iran, but this situation remains very fluid.
Most recently, Israel and Hezbollah, a Lebanon-based militant group backed by Iran, have been trading fire across the Israel/Lebanon border. Iran is in fact a major oil producer and its exports have grown by over 400 thousand barrels per day over the course of the year.[6] Thus far, the United States has turned a blind eye, failing to enforce oil sanctions on Iran, likely to secure lower energy prices globally. If the U.S. enforces these sanctions, the impact on crude oil will most likely be significant price increases, considering over 3 million barrels of supply would come off the market.[7] The United States would likely negotiate with Saudi Arabia to increase its oil production amid Iranian oil sanctions; but so far this year, Saudi Arabia has limited its oil supplies in alliance with Russia.
Crude oil and energy stocks have not advanced on the current news, but the market is trying to absorb what could potentially happen if Iran or Iranian-backed entities join the conflict. Considering that the stock market is a discounting mechanism, it is taking all of the current information available into account and trying to make sense of it. Broadening escalation is likely, and we do not anticipate this conflict will resolve quickly.
Chart 1: Map of The Conflict Region [8]
The Aerospace and Defense Impact
America has a history of standing behind Israel given its status as the only democratic nation in the Middle East. President Biden stood by this precedent, stating, “ties between Israel and the United States run deep,” and that America will offer unwavering support as, “the United States and the State of Israel are inseparable partners.”[9] Given its geographic location and its standing as the singular democratic nation in the Middle East, Israel has one of the strongest defense forces on the planet and works closely with the United States and other democratic nations to ensure freedom.
As the conflict in the Middle East continues to escalate, international defense contractors have begun to send additional aid to Israel. Since 2012, Israel has spent an average of 5.28% of its GDP on defense spending.[10] As of 2022, Israel ranked #10 globally in terms of percentage of GDP spent on military spending. Considering the large interests in the nation, defense stocks have seen a surge in share price following the surprise invasion. However, the longevity of the rally depends on various factors, such as the continued response from Israel, the corresponding response from Hamas and the value of aid sent from the U.S. to ensure peace in the region. While aid has been sent from various defense contractors, the value sent is unknown at this time. Like the share price movement in energy stocks, the market is discounting the possibility of a long-fought war. Further, the rally comes after a month of poor performance from aerospace and defense companies. The iShares U.S. Aerospace & Defense ETF (ITA) was down 8% in the month preceding the invasion, however, has risen 5.20% since.
[1] Source: WSJ. As of October 11, 2023.
[2] Source: The Nation. As Of October 10, 2023.
[3] Source: The Wall Street Journal. As Of October 7, 2023.
[4] Source: Carnegie Endowment For International Peace. As Of March 30, 2023.
[5] Source: Politico. As of October 7, 2023.
[6] Source: Aljazeera. As Of October 10, 2023.
[7] Source: The Wall Street Journal. As Of October 9, 2023.
[8] Source: FactSet. As of September 20, 2023.
[9] Source: White House. October 9, 2023.