Middle East conflict: The oil shock risk is back
Where we are now. Tensions in the Middle East have escalated once again, with daily exchanges of strikes between Iran and US assets in the region. Shipping through the Strait of Hormuz (SoH) has again stalled, and now the conflict may threaten alternative routes by which oil exports have carried on from the region (see overleaf). We think the near-term chance of deescalation is limited, but a shift towards renewed US-Iran negotiations is likely by around mid-August. Until then, the commodity impact once again looms for inflation and the direction of central bank policy, which may drive a short-term drag to market performance.
- Red Sea routes are now under threat. Since the conflict began, Saudi Arabia has been able to divert oil flows through its East-West pipeline and then onto ships in the Red Sea, thereby limiting the oil market effects of the SoH closure. That transit pathway is now under threat: On 23 July, two Saudi ships in the Red Sea were struck by Houthis.1 This stands in marked contrast versus 2024, when shipping traffic through the Bab el-Mandeb fell heavily as a result of Houthi attacks on vessels. At that time, the Houthis had avoided striking Saudi cargos. Now, markets fear that the Red Sea route will see more limited traffic and jeopardize oil flows.
- Strategic reserve drawdowns are nearing their limit. Drawdowns from national reserves have helped keep oil prices capped in recent months but we think limits are starting to be reached on how much more can be drawn down. The US Strategic Petroleum Reserve (SPR) levels have fallen to lows not seen since the SPR was first built up in the mid-1980s (see chart overleaf).
- Refined products are tight. Stocks of refined product are increasingly seeing attention. Refining capacity has been damaged in both Russia and the Gulf, and there is trapped capacity in the Middle East, highlighted by rising crack spreads. Refined product prices have been pushed up, creating a significant deviation near highs.2
Markets: Equity markets have come off their highs, but we are not seeing a deep sell-off.2 US markets have outperformed in recent weeks, but fixed income markets have come under more pressure as inflation worries return.3 European yields appear more exposed: UK 10-year gilts are above 5% again, while US 10-year yields have had a more muted reaction and are above 4.6%.4 The USD has modestly risen in recent weeks.5
Central banks: Market pricing for hikes from the major central banks has increased in recent days as participants fear the passthrough effects from higher oil prices to inflation.2 We maintain our view that the neither the Federal Reserve nor the Bank of England will hike rates this year as these are supply-side shocks. The European Central Bank, however, could hike again as it appears more sensitive to inflation and policy rates are lower than in the US or UK.
What to watch: For oil prices (and broader markets) we think the key element to watch is whether and where strikes are expanded. Should energy producing infrastructure in the region be hit then that will likely put upward pressure on oil prices. Should tankers in the Red Sea be hit and Saudi exports from that area fall then again, we would expect oil prices to rise. We are watching the combination of crude prices and crack spreads as the end-product costs are what directly affect inflation and the cost pressure that is imposed on consumers.
So what? We had argued previously that our status quo scenario was the most likely, a tit-for-tat between the US and Iran whereby shipping traffic remained below 50% and oil prices remained above $100/bbl. Following the signing of the 14 June Memorandum of Understanding, that looked rather pessimistic. But, as has been seen, that was a fragile agreement. We see a relatively low likelihood that tensions in the region ease significantly enough to ease shipping, crude prices, and indeed refined products. We expect oil prices to sustain near or above $100/bbl over the coming months and will adjust our view as the facts change. Our latest scenario set has been consolidated, and key charts are shown overleaf.
Scenarios
We frame scenarios around conflict duration, energy flows, and damage to energy infrastructure.
Near-term resolution Subjective probability: 20% |
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“Status quo” Subjective probability: 50% |
Conflict resumes Subjective probability: 30% | |
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All sides cease strikes. Strait of Hormuz reopens and tanker traffic increases meaningfully, above 50% of pre-crisis level in H2. |
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Limited strikes by Iranian proxies in the region and periodic kinetic events. Strait of Hormuz tanker traffic, in both directions, shows gradual increase in H2 but remains well below 50% of pre-crisis |
Iranian proxies ramp up attacks in region. Saudi oil exports via Red Sea limited. Strait of Hormuz traffic remains heavily impaired through at least August. |
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Potential market implications
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Potential market implications
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Potential market implications
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Sources: Invesco Strategy & Insights, Bloomberg L.P., International Energy Agency (IEA), and US Energy Information Administration, as of 23 July 2026. Indices in bottom right chart are: 60/40 = 60% ACWI Eq, 40% Global Bonds; Global Bonds = BBG Global Agg; (Eq) market indices: US Eq = MSCI USA Index; ACWI Eq = MSCI ACWI Index; EM Eq = MSCI Emerging Markets; China Eq = MSCI China; Europe ex UK Eq = MSCI Europe ex UK; UK Eq = MSCI UK; Japanese Eq = MSCI Japan. Returns are measured in EUR; bond indices are EUR hedged. Past performance does not guarantee future results. An investment cannot be made directly in an index.
Investment risks
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested. Past performance is not a guide to future returns.
