What we do know is that the gloves are off. After months, if not years, of shadow boxing through proxies, this weekend marked the moment of truth. Iran’s direct attack on Israel, with its own drones and missiles launched from its own territory, in response to Israel’s direct assault on the Iranian embassy in Damascus, clearly opens a new chapter in Middle East geopolitics. 

What we do not know is what happens now and how that will impact on the global economy. Will the conflict spread out of control into a full-scale regional conflagration between Israel and Iran and their respective allies? Or will both sides step back from the brink and begin, through back-channel diplomacy, a process of de-escalation?

Israel’s response

Most analysts at this point seem to believe that, from the Iranian side at least, the objective of this attack was to escalate to de-escalate, rather than as the opening salvo of a regional war. As Firas Maksad, senior director at the Middle East Institute, points out, one of the reasons that the attack was so unsuccessful is that Iran had carefully telegraphed its intention to attack over 12 days.

The initial reaction from Prime Minister Netanyahu and the Israeli government was of smug satisfaction with the performance of their air defence systems, which brought down 99% of the estimated 170 drones, 30 cruise missiles and 120 ballistic missiles launched at Israel. However, their next challenge, of how to respond to the attack, is arguably even more complex.

The US is clearly pushing Israel for a measured response and is seeking restraint, with Secretary of State Antony Blinken saying Washington did “not seek escalation” by Israel.

Benny Gantz, the former general and opposition politician who joined Netanyahu’s cabinet after the outbreak of the war with Hamas in October, also urged patience on Sunday, saying Israel should not rush to take a unilateral approach to dealing with Iran.

But hardliners in Netanyahu’s coalition called unanimously for an aggressive response. Itamar Ben-Gvir, the ultranationalist national security minister, demanded a “crushing attack”.

“The concepts of containment and proportionality are concepts that passed away on October 7,” he said, referring to Hamas’s attack on Israel that triggered the war in Gaza. “In order to create deterrence in the Middle East, the landlord must go crazy.”

Bezalel Smotrich, Israel’s far-right finance minister, made similar demands. “If our response resonates throughout the Middle East for generations to come – we will win,” he said. “If we hesitate, God forbid, we will put ourselves and our children in existential danger.”

Impact on the economy

What course of action the Israeli government takes matters, both for the security of the region and the global economy. The most direct link between the two is, of course, the oil price.

As with all commodity markets, the price of oil is simply a question of how much oil the global economy is consuming and how much the world is producing.

First, the shock of this weekend comes against a backdrop in which Opec was pursuing a goldilocks strategy, of getting the oil price “just right”. It does not want it too high to crush the global economy and weaken demand, but wants it high enough to ensure its colossal petrodollar cash flows continue to flow. This is likely to continue. It is not in anyone’s interest within Opec to push the global economy into a recession, as happened with the supply shock that followed the 1973 Arab-Israeli War.

Second, in terms of pure physical supply of oil, nothing has yet changed in the Middle East. Crude is being produced and exported as before, and the Strait of Hormuz – the world’s most important energy bottleneck – remains safe and open. Since the attack, the oil price is broadly flat – it would seem a lot of the risk was already priced in prior to Iran’s action.

And yet there can be no doubt that the risk of a future disruption has increased. Should Israel go down the route of an all-out assault on Iran, production and shipment of crude will almost certainly be deeply affected, potentially causing a Gulf War-style price spike. Furthermore, with traders now anticipating tighter crude and product fundamentals, markets are now more sensitive to the risk of potential geopolitical disruptions to supply.

Third, in terms of demand, the global picture looks relatively robust. As Ben Cahill and Raad Alkadiri, from the Centre for Strategic and International Studies, point out, market fundamentals should continue to underpin higher oil prices through the remainder of the year. Oil demand growth in the first quarter was relatively strong, with the International Energy Agency recently upgrading its first quarter demand growth figure to 1.7 million barrels per day (b/d). The agency has raised its 2024 demand forecast to 1.3 million b/d – far lower than last year’s 2.3 million b/d, but still strong by historical standards.

Asymmetrical impacts

In sum, therefore, while prices have already increased substantially in 2024 – Brent Crude is up 16% year to date, and has been hovering around $90 a barrel since early April – there seems a sizeable probability that it could go even higher.

The impacts of that would be, as ever, asymmetrical. Oil exporters such as the Gulf nations, Russia and the US stand to profit. Energy importers, particularly emerging market ones such as SA, will suffer. Higher oil prices will hurt South African consumers and businesses while worsening inflation. It could give the Reserve Bank reason to delay any rate cuts, further dampening SA’s already dismal growth prospects.

However, the biggest losers in all this are the Palestinians of Gaza. For all Iran’s supposed support for them, its attack may well push the humanitarian crisis there down the global agenda just as calls for an immediate ceasefire and greater humanitarian access were gaining momentum. Negotiations over the Israeli hostages are likely to be suspended for some time. 

As long as Washington refuses to force Netanyahu to act within humanitarian law, conditions for people in Gaza will only get worse. DM