Ramifications of Israel-Gaza conflict could affect rest of MENA, says Capital Economics

“The outbreak of conflict between Hamas and Israel has not yet spilled over into the wider region. But the situation is in flux and, if Iran is pulled into direct conflict, the ramifications for the region would be a lot larger,” James Swanston, a Middle East and North Africa economist with Capital Economics said in a note.

Israel has declared a “complete siege” of Gaza and threatened a ground offensive into the territory that is expected to come any day. Residents in northern Gaza have been ordered to evacuate and NGOs estimate around one million people have left their homes but remain trapped inside Gaza as the borders have not been opened.

Meanwhile, Iranian-backed Hezbollah has begun firing missiles from southern Lebanon into Israel.

“The provocation from Lebanese Hezbollah provides the most direct threat right now of spillovers into the wider region, particularly if it were to provoke a larger counteroffensive from the Israeli Defence Force. The major risk is that this could turn the conflict into outright war between Israel and Iran,” says Swanston.

What analysts are most afraid of is if Iran gets drawn into the war, as that will impact oil markets. Iran has managed to ramp up in its oil production in recent months to more than 3mn bpd in August, but that could quickly reverse if Iran enters the war. If it was then Israel would likely target Iran’s oil infrastructure.

“Even if outright conflict between Israel and Iran were avoided, reports that Tehran helped Hamas to plan the attack on Israel may prompt the US to clamp down on Iran’s energy production in order to cut off a financial lifeline,” says Swanston.

“If Iran’s oil output were to be dented, it would push oil prices higher. The price of Brent crude has risen 3% to $86pb since last week, and had hit $89pb earlier on Monday over supply disruption fears. Our Commodities team outlined that the relatively modest rise in oil prices seen so far reflects the fact that the risks to supply are still just that – risks. If the risks were to materialise, however, we would have to consider raising our forecast for the Brent crude price for end-2024, which is $85pb currently,” adds Swanston.

For the Gulf economies, a higher oil price without a hit to their own output would be net positive.

“On the geopolitical front, though, the Gulf finds itself in a tough predicament. In August 2020, Israel and the UAE signed the Abraham Accords to normalise relations, and this was swiftly followed by an agreement with Bahrain. And more recently the US had been brokering talks between Saudi and Israel to normalise relations too. Those Saudi-Israel negotiations are now firmly on pause. In a statement, the kingdom did not condemn Hamas’ attack and repeated its support of the Palestinians – even before the war, Saudi Arabia’s push for Israeli concessions to the Palestinians had been a sticking point in talks,” says Swanston.

Relations between Iran and the Gulf have improved in recent years, particularly with the China-brokered restoration of diplomatic ties between Saudi Arabia and Iran.

Crown Prince Mohammed bin Salman spoke with Iran’s President Ebrahim Raisi on October 11, and communicated the desire to de-escalate the conflict in Israel. Such talks would have been unthinkable just a few years ago. but Capital Economics cautions that the rivalry between the Gulf countries, including notably Saudi Arabia, and Iran has not completely subsided.

“Over a longer horizon, the current conflict could have major implications for how the geopolitical sands in the region are shifting. With the US sending more direct military aid and moving military ships and aircraft closer to Israel, the Gulf states could seek similar support if security risks in the region are heightened. Indeed, as part of normalisation talks with Israel, the US and Saudi Arabia were reportedly discussing a mutual defence treaty. This may signal that the US wants to continue to compete with China’s (growing) influence in the region,” concludes Swanston.