The Middle Eastern Cold War: The Spark of the Next Great Recession?
Introduction
Today’s globalized economy has created an environment of net dependency. The costs of war have significant consequences, not only for nations engaging in conflicts, but for its trading partners as well. This impact was seen most predominantly in the 2008 recession, when a housing crisis in the US had rampant spillover effects on the global economy. Analysts have termed the current economic scenario a strong “recession climate” based on projections of business cycles and bond market yields. But if everyone expects a recession, why isn’t it here? Recessions commonly begin where fear of economic downturn causes investors to limit spending and creditors to raise payments.
According to academia, two probable sources of economic turmoil include political incompatibility, and overvaluation bubbles. The US-China trade conflict and the WeWork incidents are notable examples. However, global oil supply reliability is often excluded from public discourse. The decade of stagflation following the 1973 oil supply fluctuations is a stark reminder of oil’s importance, and also demonstrates the effects oil can have on global geopolitical forces. The proxy war between Iran and Saudi Arabia sparked as a result of ideological differences on the Shia-Sunni sectarian divide is a noteworthy recent demonstration of the instability experienced in the Middle East. Thus, socio-political forces controlling oil production also play a noteworthy role in molding the global energy ecosystem.
Importance of Oil
Why is oil important? The fossil fuel industry is the most valuable industry in history by production, drawing value from its reach and resilience. From plastics to transportation, from automation to energy, the global industrial revolution wouldn’t have occurred at its pace without oil and its numerous by-products. Oil’s omnipresence in global supply chains also stems from the ease with which it can be transported relative to other resources. For example, natural gas has been recommended as an alternative under UN Sustainability Goals due to its more carbon-neutral nature, but due to its high cost barriers, industries continue to rely on oil. Oil’s prevalence is highly disruptive as price increases to oil directly translate to spikes in global production costs, an issue affecting the competitiveness of many industries.
US Oil Trade
To understand oil’s importance in US foreign policy, an understanding of long-standing oil alliances is fundamental. The main threat to the current supply chain is the proxy war between Iran and Saudi Arabia. A proxy war refers to a state of military conflict exercised not directly by any state actors but instead via regional non-state organizations to further ideological interests. Iran and Saudi Arabia’s stand-off on numerous interlinked regional turmoils affects not only their oil exporting capabilities but also the US’s core oil exposure. But, is the US truly dependent on Middle Eastern oil? Contrary to general belief, the US is a net exporter of oil, surpassing nations including Saudi Arabia and Russia in oil production. However, oil markets are geographically-driven due to distribution and transportation costs. Since not every country can afford to buy from the US, several suppliers are necessary to sustain the global demand. Furthermore, given the market share that Middle Eastern countries control, their supply keeps prices in check, as was confirmed by the price surges in the aftermath of September’s drone attacks on Saudi Arabia’s state-owned production facilities. Hence, even if the US is able to thrive on its own oil supply, its diversified economic interests mandates that its key partners and allies do not lose vital supply chains tied to the Middle East. Similarly, China’s rampant economic production lies vested in Iranian and Saudi Arabian oil production, establishing the regional oil’s delicate geopolitical importance.
Political Instability in the Middle East
An important facet of this discussion is the role that instability across oil-supplying nations in the Middle East play in leveraging national resources. Three notable incidents of political unrest include the 1979 Iranian revolution, the Yemen Houthi insurgency, and the United States’ arms deal with Saudi Arabia.
The House of Pahlavi (Iran’s former royal family), was overthrown in the 1979 revolution, causing a shift in policy towards isolationism. This shift had catastrophic implications on access to Iranian oil supply by constraining distribution and production channels.
Further instances of instability arise from the exacerbation of existing conflicts across the region, particularly Syria and Yemen. The decade-long Yemen Houthi insurgency, along with its accusations of Iranian involvement, has stoked a Saudi-allied response, embroiling the country into a civil war spiral. The Syrian front has been pronounced by the rise of Islamic State, and Iranian support for the Assad government in the wake of public uprisings. While the United Nations Security Council (UNSC) did attempt to dissipate conflict through landmark policies enshrined in UNSC Resolutions 2159 (2014) and 2239 (2015), the sanctions failed to yield substantial effect. This failure was particularly pronounced, since major Iranian oil importers like India, Turkey, and China continued to tap into the existing oil supplies, nullifying intended repercussions.
Saudi Arabia and the United States have long shared a symbiotic relationship born from mutual objectives in the Middle East, including the Israel conflict, and Iran’s position in the status quo. Evidenced by the $110B arms deal to help Saudi Arabia purchase US arms in 2017, the United States has asserted its motives in regional geopolitics. In spite of international criticism of US support for Saudi Arabia, mainly concerning the latter’s poor human rights record and hostile political environment to curb free expression, the US remains adamant on asserting the vitality of Saudi Arabia in establishing peace across the region’s conflicts. This relationship has inevitably affected the proxy war, with several non-state actors being accused of “harbouring violence”, from attacks on oil tankers in the Strait of Hormuz, drones near Persian Gulf, and rebel forces on the Yemen border.
The recent drone attack on Aramco, Saudi Arabia’s largest state-owned oil producer, was the largest sudden disruption on the International oil supply since the Gulf War. With Aramco responsible for over 5% of global oil, prices briefly peaked in commodity markets before production was reinitiated. This orchestrated a potent demonstration of the political and economic structural power that independent actors in the Middle East yield on larger global processes, as demonstrated by the Yom Kippur War.
Yom Kippur and the Decade of Stagflation
The Yom Kippur War in 1973 between Israel and the Arab coalition led by Egypt for control over the territories of Sinai and Golan led to blockades of major supply routes due to disputes over the Suez Canal, effectively ceasing oil distribution. In combination with the fall of Bretton Woods, a system of procedures for major economies to ensure their economic stability, poor investor confidence and rising production costs heralded a decade of stagflation, characterized by high unemployment and high inflation.
Distortions in commodity markets extended the effects of stagflation across major Western economies, with sudden peaks in treasury rates, as seen above, and a quarterly negative GDP growth over 1973–1975 causing the UK filing for bailout with the International Monetary Fund in 1976. The price spike was detrimental to dependent industries including shipping, logging and mining, with the Swedish ship-building industry losing over 3 billion Swedish Krona in 1974. As recovery from this energy crisis lasting over 14 quarters, several nations have come to realize the influence of Middle Eastern oil on national policy-building.
Conclusion
It is unequivocally imperative to recognize a distinction between perceived and actual costs of the Middle Eastern war, with the latter based primarily on probable disastrous economic consequences that can ensue due to disruptions to oil. With heightened political instability across the region, countries must attempt to divest their economic interest away from geopolitics in order to distance themselves from its instability. The attack on Aramco, the rise of Iran’s nuclear program, and guerilla proxy outbreaks serve to aggregate underlying conflicts, being a formidable reminder that intricately tying global economics to political friction is a recipe for recessionary disaster. In addition, while alleged religious incoherence continues to feed unrest, decoupling dependency on the region’s oil is our only hope to normalize commodity volatility and, in effect, at curbing the next energy crisis.
About the Author
Muhammad Sadiq is a 2nd year Accounting and Financial Management student at the University of Waterloo. Originally born in Pakistan, Muhammad and his family travelled and lived in many Middle Eastern countries such as Saudi Arabia, Iran, Bahrain and Dubai before immigrating to Canada in 2007. These experiences have shaped his view and fueled his interest in understanding the geopolitics of the region.
In high school, for his thesis project, Muhammad explored the impact of Saudi Oil on international trade and western foreign policy. In financial studies, it has become crucial to understand the role oil markets play in global economics and this understood partly by the political relationships between nations most invested in oil-exporting.
His interests include exploring and explaining to consumers the impacts of their behaviours have on shaping nations around the globe and why embracing disruptive tech are potential solutions to many of the world’s problems. Tune in to the next issue of WBR to catch his upcoming article exploring Central Banking and Cryptocurrency.
