Smoke rises after a strike on the Bapco Oil Refinery on Sitra Island, Bahrain, on March 9.Stringer/Reuters
John Rapley is a contributing columnist for The Globe and Mail. He is an author and academic whose books include Why Empires Fall and Twilight of the Money Gods.
Game theorists have begun applying their theoretical models to the Middle East war to predict its likely course. Broadly, they fall into two camps.
Optimists maintain that both sides are suffering economic damage from a prolonged conflict and thus share an interest in bringing it to a speedy resolution. So far, most investors appear to share this view, which may explain why markets have remained relatively resilient so far, even as Iran escalated this week by striking Gulf refineries.
Stocks have been down but not far off their recent highs. Futures pricing expects oil prices to stay elevated and inflation to rise, but also suggest traders are taking at face value the Trump administration’s claim that this war will be over in weeks.
However, such equanimity can be deceptive. When Russia invaded Ukraine in 2022, it took five weeks until markets really registered their concern. We could see a pause now, maybe even a bit of a rally. Canada and its allies have said they would “contribute to appropriate efforts to ensure safe passage through” the Strait of Hormuz. But they did not say how or when. If the Strait remains closed as we enter April, sentiment will likely darken again.
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At the moment, there’s no sign of an imminent reopening. Iran is allowing ships that carry its oil to sail freely, and the U.S. is letting them pass to avoid further disruption to global markets. But it’s inconceivable that Washington will tolerate this indefinitely, as it effectively grants Iran control of the Strait. And the Iranian regime, seeing the power that control of the Strait has given it, will be equally reluctant to give that up in any future ceasefire negotiations.
That’s why many game theorists lean toward an escalation scenario, in which the standoff deepens. Some scholars believe the parties to this conflict are now caught in a dangerous Nash equilibrium, a situation in which neither actor perceives any benefit from changing course. If so, it seems inevitable that a military confrontation to try to force open the Strait of Hormuz will eventually occur, unless one side capitulates.
The White House’s apparent reluctance to act directly suggests it sees no clear or painless way out. It’s not obvious that naval escorts would open the Strait, because ships at risk of attacks – which would likely still come – might still struggle to get insurance, in which case they’d likely stay away. Instead, it might entail a military occupation of at least a part of Iran, which would be a very dangerous prospect. For what they’re worth, prediction markets do not expect a ceasefire before June at the earliest.
In sum, rather than a speedy resolution, the most likely scenario would seem to be a continuation of the current standoff, with the Strait remaining largely closed. If, as a result, oil shipments out of the Gulf remain as low as they are now, the supply-demand imbalance will soon intensify, and the price of oil will resume its upward climb.
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Just how high it could go remains a topic of debate among experts, but some market analysts estimate that the scale of demand destruction required to restore equilibrium to the market could be as high as US$200 a barrel – in short, a global recession on the scale of the COVID-19 downturn.
What could make this recession worse, though, is that governments would have less fiscal firepower to fight it – given how much debt they accumulated in the pandemic era – while central banks are concerned about inflation spinning out of control and will hesitate to underwrite further borrowing. A few oil and gas producers might cheer such prices but most everyone else will end up worse off.
Nor is the cheering likely to last long, since oil prices at that level would likely cause a permanent reduction in long-term demand. For instance, within Europe, it’s been interesting to contrast the response to the surge in oil prices of Germany and Italy, which rely on gas-fired electricity, with Spain and France, which use renewables and nuclear. Germany and Italy are in a panic whereas Spain and France have remained relatively calm, since their energy prices have risen much less, making their firms more competitive.
The biggest energy infrastructure build-out in history is under way in the developing world right now, and countries can still choose what energy mix they want. For oil- and gas-importing countries, nothing makes the case for cheap, locally sourced renewable energy like an oil shock.