Over the weekend, the U.S. and Israel launched military operations against the Iranian regime. Since then, counter-attacks across the Middle East have been launched by Iran.

Shipping through the Strait of Hormuz, which transports about a fifth of global oil and liquefied natural gas (it is also a key route for fertilizer), has been effectively closed.  

Concerns over supply disruptions have pushed WTI oil prices up by 5-6% relative to Friday’s close, with recent trading in the US$70-72 range – the highest since last summer.

Recent geopolitical events have had only a brief impact on oil prices as the physical supply of oil was not seriously affected, including January’s U.S. invasion of Venezuela. This time is different because the physical flow of oil and natural gas are facing a potentially large and prolonged disruption in the Strait of Hormuz in addition to key export infrastructure in Iran, itself a major producer.

OPEC+, meanwhile, has announced an oil output increase of 206,000 barrels per day, but this is not going to make much difference if the Strait of Hormuz stays closed given the approximately 20 million barrels per day that flow through it.

How could this impact Canadian oil and gas producers? ATB Cormark Capital Markets, in a report released this morning, notes that there is a “structural physical deficit” concentrated in heavy and sour grades of crude oil. This will create a demand for Canadian heavy barrels: “If the situation persists, there is the potential for prompt WCS differentials to narrow by roughly ~US$3.00/bbl; based on TMX landed cost advantage to Asia.”

The other part of the market facing the most acute shortfall is LNG, ~20% of the world’s LNG trade is trapped behind the Strait, the majority of which is bound for Asia. LNG Phase 1, which came online this past summer, has been ramping up towards capacity, allowing Canada to play a role in the global LNG trade. This event will likely support higher North American natural gas prices and encourage higher utilization where possible.

Longer-term, ATB Cormark Capital Markets highlights that “geopolitical tensions continue to support our core thesis to the shifting paradigm around the quality and duration of Canadian oil and gas assets and relative jurisdictional stability that supports current valuations and further multiple expansions.”

In other words, Canada is well positioned as a safe-haven destination for oil and gas production, assuming sufficient pipeline capacity is available to facilitate growth.

It’s too early to speculate as to what’s next. Duration is key, with the financial market and economic implications intensifying the longer the attacks last. President Trump has indicated the attacks could last four or five weeks. Despite the many unknowns, we offer the following points:

Increased uncertainty and lower confidence - Economies around the world, including Canada’s, were already facing the dampening effects of heightened uncertainty related to U.S. trade policy and shifting geopolitics. The violence and spillover effects of what is currently happening in the Middle East will lead to uncertainty – an additional headwind to growth.

An inflationary shock - Recent soft economic data has raised the possibility of a Bank of Canada rate cut, but now the Iran crisis adds to price pressures and pushes in the other direction. Overall, the attacks reinforce a “wait and see” data dependent approach. For now we retain our call for the Bank to stay on the sidelines this year. However, the attacks, especially if drawn out, put rate hikes back on the table.

Energy producing provinces will outperform - As highlighted above, Canadian producers are well positioned in the near term given the supply deficit of heavy crude oil and LNG. Longer-term, it reinforces the importance of long-lived assets in democratic countries like Canada. However, the ability to increase production remains constrained by limited egress, putting attention on the execution of the Alberta-Canada MOU designed (among other things) to increase export capacity. Further, while higher prices lift incomes in provinces like Alberta, Saskatchewan, and Newfoundland and Labrador, consumers will see higher prices at the pumps and pass-through to other goods. Industries outside oil and gas (and related) will not see an uplift, and in fact, could see activity slow due to increased uncertainty and softer global demand.

This is a dynamic situation that we will continue to monitor. We will provide updates as we learn more.

Answer to the previous trivia question: Nvidia was founded on April 5, 1993.

Today’s trivia question: What film featuring a giant primate premiered in New York City on this day in 1933?