A Wider Middle East Conflict Could Worsen Supply Chain Disruptions – Here’s Where and How

Abstract

As disruptive as Houthi attacks on commercial shipping in the Red Sea have been for supply chain and logistics, the prospect of a wider regional conflict between the U.S. and Iran could quickly make it go from bad to worse.

Article

Houthi’s Red Sea Attacks Adding Shipping Expense, Time, and Risk as Suez-bound Shipping Reroutes Around Africa

Since November, Yemen-based, Iran-backed Houthi rebels have attacked commercial shipping transiting the strategically vital Suez Canal, Red Sea, and Bab al-Mandab Strait. They’ve done this in solidarity with Hamas and the Palestinian movement and in an attempt to pressure Israel and the West to end the war in Gaza. You can read our prior coverage on the topic here. We also have some updated data for you below.

Prior to November, 12% of global trade, 30% of container shipping, and seven million barrels of crude oil and refined energy products passed through these waterways daily. That’s no longer the case, as the Red Sea has become a literal warzone. As of February 2, 30 commercial ships have been attacked, 13 have sustained direct hits, and several have been severely damaged. 

Image by Alexander Bobrov from Pixabay

The route isn’t just operationally risky for carriers and customers; it’s also financially risky for insurance underwriters, who have widened the risk zones and raised insurance rates, particularly for U.S., UK, and Israeli-linked companies, if they insure them at all. As of February 7, war underwriters were charging 1%, give or take, of a ship’s total value while transiting the high-risk zone to insure the vessel, compared to 0.1% or 0.2% before the attacks.

As a result of the attacks on shipping and insurance spikes, more than 750 container ships, plus many tankers, bulk carriers, car carriers, and other merchant ships, have diverted from the Red Sea since November. They’re sailing alternate routes around the Horn of Africa, down to the Cape of Good Hope, east toward the Indian Ocean, or west from the Mediterranean out to the Atlantic Ocean. But these alternate routes expose ships to piracy and add 3,500 nautical miles to a ship’s journey, which increases lead times and inflates the costs of the shipment. 

Shipping companies (ocean carriers) don’t have many choices. They must pivot, shore up or recoup losses, and stay in the game to preserve market share. While they struggle to remain in the market, shippers and freight forwarders lose the capacity to ship quickly through the region and are likewise left with few good options. Similarly, beneficial cargo owners are left with a lot of uncertainty in the costs and lead times for moving their goods.

International Efforts to Protect Shipping

Source: U.S. DoD News, Photo By: Petty Officer 3rd Class Samantha Alaman,  VIRIN: 231125-N-WJ225-2207Y, Public Domain
USS Mason and Japanese destroyer Akebono in Gulf of Aden during Operation Prosperity Guardian

To uphold freedom of navigation and protect commercial shipping, U.S. Navy warships and aircraft patrolling the Red Sea have been intercepting dozens of Houthi missiles, unmanned aerial vehicles, and uncrewed surface vessels targeting civilian and military shipping. In one incident, U.S. Navy helicopters fired on four Houthi fast attack craft that had fired on and attempted to board a commercial ship, sinking three and killing ten Houthi militants. 

The U.S. government has also launched Operation Prosperity Guardian, a multinational coalition of more than 20 nations, including ten anonymous members, to provide security assistance to commercial shipping transiting the Bab al-Mandab Strait and the Red Sea. It’s helped, but it’s not enough to stop the attacks.

On January 11, U.S. and UK forces began conducting a series of air and missile strikes on Houthi targets in western Yemen to degrade its missile and drone capabilities and deter further attacks. Despite follow-on strikes, round-the-clock intelligence, surveillance, and reconnaissance activity, and preemptive “self-defense” strikes on targets, the Houthis have continued to attack shipping. 

We shouldn’t be so surprised. 

The Houthis are a notoriously resilient militant group that have managed to weather a nine-year conflict with Saudi Arabia and other Gulf Coast Countries, all of which have qualitatively and quantitatively superior military capabilities. Moreover, the Houthis struggle to govern competently. They are insurgents, not technocrats. When the Israelis invaded Gaza in response to Hamas’ October 7th massacre, the Houthi leadership seized an opportunity to return to what they do best … fighting. And it is a relatively popular move among their populace. Even many of those who resent the Houthis’ dismal governance are supportive of these attacks. The Houthis vowed to continue attacking Red Sea shipping for the duration of the Israel-Hamas war, which could last many more months given that Israeli, Hamas, Arab, and Western leaders have struggled to reach a mutually acceptable peace agreement.

The Wider Middle East at War

Houthi attacks on shipping in the Red Sea represent just one strand of an unraveling security situation in the Middle East that threatens regional commerce and the global economy. While some of these incidents are being spurred on by the Gaza War, many are the result of other ongoing regional rivalries and tensions, or are continuations of existing conflicts, such as Iran’s ongoing efforts to expel U.S. forces and influence from the region and Iran’s ongoing low-level conflict (often via proxies) with Israel, Saudi Arabia, and other Sunni Arab states.

Iran-backed Lebanese Hezbollah has been attacking Israel from the north, drawing Israeli retaliatory strikes on leadership in Lebanon and Syria, in addition to Gaza and the West Bank of Jordan. Jordanian forces have struck Iran-backed drug traffickers in Syria. Iran and Pakistan attacked the same Balochi separatist groups on either side of their borders. 

The Iran-backed Islamic Resistance in Iraq, specifically Kata’ib Hezbollah, has struck U.S. and U.S.-backed forces in Iraq and Syria deployed to defend oil fields and combat what remains of ISIS. These attacks have occurred over the last several years. But on January 28, Kata’ib Hezbollah attacked a joint forces outpost in Jordan, killing 3 U.S. soldiers, wounding 47 others, and putting the U.S. and Iran on a collision course that threatens to escalate an already explosive geopolitical situation. The attack so imperiled regional stability that it prompted U.S. Secretary of State, Antony Blinken, to declare the Middle East is at its most dangerous point in more than 50 years.

In response, the U.S. launched a series of attacks on Iran-backed groups operating out of facilities in Iraq and Syria linked to Iran’s elite, clandestine Islamic Revolutionary Guards Corps (IRGC) Quds Force – but reportedly, without killing IRGC members, themselves. That could be the point – to respond to Kata’ib Hezbollah’s attacks, degrade its capabilities and leadership, and reset deterrence with Iran and its proxy groups without drawing Iranian blood. After all, Iran has warned the U.S. that striking its territory, interests, or people would cross a red line. The Biden Administration seems keen to walk right up to the line without crossing it.

Source: Library of Congress, Public Domain
Figure 1 – Incidents in the Middle East Since Hamas’ October 7th Attack on Israel


What Could Happen Next – and What to Watch

Still, there remains the potential for future deadly attacks on U.S. personnel, and it begs the question: how would the U.S. respond? And what would happen if IRGC members are killed in future strikes? How would Iran respond? Which dominoes would fall next in the Middle East, and how might they impact businesses? 

The deadly January 28 attack on U.S. soldiers has drawn the U.S. and Iran the closest to open and direct conflict in nearly four years. The last time we were in this situation, January 2020 following the U.S. assassination of IRGC Quds Force leader, Qassem Soleimani, the two countries went tit-for-tat and called it a day, not wanting to escalate the conflict to an all-out war. Cooler heads prevailed then. But Iran has an ace up its sleeve: the oil card. 

The Persian Gulf and Strait of Hormuz

Iranian leaders have previously threatened to close the strategically important Persian Gulf and Strait of Hormuz, through which 21 million barrels and 21% of the world’s oil passes daily. It’s one of the most plausible locations in the region where the conflict could spread, in part because it’s happened before.

Source: Image by Gerhard Traschütz from Pixabay

Iran has held the Strait of Hormuz at risk for forty years, beginning with its actions during the “Tanker War” with Iraq during the 1980s. The two countries launched missiles, laid naval mines, and employed surface combatants to conduct attacks on each other’s container ships, military resupply ships, and tankers, with many damaged, sunk, or written off. 

Iran appears fully capable of following through on its threats. Its arsenal of missiles, naval mines, and fast-attack craft has expanded in scope and sophistication since the Iran-Iraq War and the Tanker War. Iranian forces have already been found placing limpet mines on shipping in 2019, 2020, and 2021 in brazen attacks that pre-date much of the region’s current hostilities. 

Whether Iran follows through with its threat may be irrelevant – merely threatening to mine the Strait and attack commercial shipping is enough to inflict economic damage. It spooks oil futures traders and spikes prices, which would benefit Iran because it’s a rentier state that relies on the flow of its oil and natural gas reaching international markets.

Saudi Arabia’s Energy Infrastructure 

Iran wouldn’t have to cut off its nose to spite its face if it wanted to retaliate against the West in an asymmetrical manner. Houthi forces, with Iranian intelligence, munitions, and command and control, could easily strike Saudi Arabia’s vast oil extraction, refinement, and distribution infrastructure via coordinated missile and drone strikes. 

The Houthis have pulled this off within the last ten years, most notably in 2019, 2020, 2021, and 2022 when Houthis targeted the Saudi capital, Riyadh, Saudi Aramco energy facilities, airports, a water desalination plant, and other critical infrastructure. Energy and commodity markets were affected to some degree ranging from mild to moderate impact, with fluctuations in volume and pricing seen in the markets. The 2019 attack on Abqaiq-Khurais took 6% of global oil production down for 10 days and led to a brief price spike.

Direct Attacks on U.S. Targets

Source: The U.S. National Archives, Public Domain
USS Vicksburg, Roosevelt, Carney, and Sullivans; coordinated volley in an exercise to intercept hostile missiles

This is another scenario with recent precedence. It was only four years ago that IRGC forces fired more than a dozen medium-range ballistic missiles at U.S. forces at Al-Asad Airbase and Erbil, Iraq, in retaliation for the assassination of IRGC Quds Force Commander, Qassem Soleimani. The attack resulted in the wounding of more than a hundred U.S. soldiers, most with traumatic brain injuries, and the tragic deaths of nearly 300 civilians when Iranian air-defense forces mistakenly shot down a civilian airliner over Tehran that night. 

There are potential scenarios where this plays out once again. If Houthis manage to hit a U.S. Navy vessel in the Red Sea, or if Kata’ib Hezbollah or other Iranian-proxy groups kill additional U.S. service members, the U.S. could then take direct action against Iranian forces as a more forceful response. This could in turn draw a harsher response from Iran, and so on. Where this would end, no one knows. Neither side wants war, and we’d hope that cooler heads would prevail in such a circumstance – but it remains a big unknown.

Implications for Global Supply Chains

Many companies will have to operate in this precarious business environment for the foreseeable future. For many of these companies, the operational status quo is already unsustainable, and it could get worse. 

For business leaders, and supply chain and procurement leaders in particular, the last thing they need is to see any of the several ongoing conflicts in the Middle East escalate or spill over into other parts of the region. It’s also why they need to pay close attention to what’s been happening in the Middle East and what happens next so they can get ahead of it, be responsive, be agile, and be resilient.

The common actors in all of these scenarios, to some extent, are Iran and the U.S. They’re not engaged in direct or open conflict with each other – only by proxy, so far. If Iran gets further and more directly involved, and trades blows with the U.S., we know that oil prices are likely to spike. We’ve seen this happen before, and very recently. Hedging oil prices (e.g. via current and futures contracts, oil call options, collar hedges, and swaps) would seem like a good idea now, except those hedges might also be rather expensive. But, it’s very difficult to “time the market,” and traders may have even less of a sense of this than carriers, shippers, and logistics teams. 

Those who already hedge oil may want to hedge more aggressively (larger amounts and longer timeframes) and those who don’t hedge at all should consider starting.  We also advocate the use of cross-functional hedging teams to design and implement smarter hedging strategies, and get more bang for the buck from hedging investments.

One thing is for certain: 2024 is shaping up to be a very dangerous and fluid year, particularly in the narrow and cramped waters of the Middle East. The implications for future economic and business trends are uncertain, at best – no one knows what’s going to happen next. But it could be very consequential to regional stability and the global economy. 

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