Gulf risk goes beyond a blocked Strait of Hormuz

There's a straightforward way of thinking about the financial risks of the current conflict in the Middle East. On this simple view, escalating hostilities between Iran and Israel will only become materially relevant for investors if Tehran shuts the Strait of Hormuz, stopping a key flow of global oil deliveries and sending prices skyrocketing. That theory has merit, but it underplays the possibility of other things going wrong.

Investors seeking reassurance have plenty to cling to. While Israel has expanded its theatre of operations from strikes on Iranian commanders to energy infrastructure, it has steered clear of Iran's key Kharg Island terminal, the conduit for 90% of Iran's oil exports.

And there's no sign of Tehran disrupting ships in the Hormuz corridor, through which a fifth of the world's daily crude consumption passes and which at its narrowest point is only 33 kilometres wide. Doing so would imperil the transit of oil exports that generate around $50 billion annually for the battered economy, suggesting Tehran has good reason to hold back. Most of all, the various flashpoints between the two states in recent years have generally ended rapidly. Those reasons explain why Brent crude prices continue to hover around $75 a barrel – up relatively little since Israel's first strikes last week.

With the conflict now in its fourth day, however, it's not obvious that cool heads will prevail. Israeli Prime Minister Benjamin Netanyahu said in a Fox News interview on Sunday that regime change in Tehran could be a result of his country's military attacks on the country. That will focus the minds of the Islamic Republic's political leaders. If it comes down to keeping the oil flowing or ensuring survival, leaders in Tehran may have a reason to expand the scope and strength of their reactions.

The conventional view is that escalation would involve blocking Hormuz or rushing to develop some of the nine nuclear weapons the Institute for Science and International Security recently said, opens new tab Iran might be capable of constructing in three weeks. Equally, however, it could see Tehran's Revolutionary Guards or Iran-aligned Houthis in Yemen train their sights on trade routes that go through the Gulf.

Iran and its proxies have long been associated with disrupted shipping in the region. In 2019, two Saudi Arabian tankers were sabotaged off the coast of Fujairah in the United Arab Emirates in a mine attack Tehran denied but the US described as "almost certainly" emanating from Iran – while back in the 1980s the Iran-Iraq war saw hundreds of international vessels targeted.

The US, Europe and Saudi blamed Iran, who again denied involvement, for the 2019 Abqaiq drone strikes that briefly took out half of Saudi Arabia's oil production. And repeated Houthi attacks in the Red Sea have prompted most global shipping to go around Africa.

If Iran and its allies go down that path again, the US Fifth Fleet in Bahrain would likely intervene to protect seabound trade. But that increases the chances that it too would get drawn formally into the current confrontation. Investors who aren't factoring in these risks may just not be looking at the right historical lessons.