A bigger war in Israel would send oil prices skyrocketing and hurt the economy's chances of avoiding a recession

• There are growing fears that the war in Israel will escalate and the US and Iran get more involved.
• The impact on oil prices would be enormous with one prediction of $150 per barrel.

While the most pressing concern in Israel is the immediate human toll as thousands have died in the conflict with Hamas, the war also has a chance of disrupting the global economy.

In the latest estimates, more than 4,100 people have died since Hamas' terrorist attacks earlier this month and Israel's subsequent war against the militant group.

As the war in Israel rages on, there are growing fears it will escalate into something much bigger, and the ripple effect could undo any hopes for the US economy to avoid a recession.

International Monetary Fund managing director Kristalina Georgieva expressed concern on Thursday over how global oil markets would be impacted by the war. Specifically, if the US and Iran were to get more directly involved, there would be significant disruptions to oil supply.

This was echoed by Bloomberg Economics, who said the big fear for the global economy is if Israel ends up in direct conflict with Iran, which could pull the US more directly into the conflict. If that were to happen, they predict that oil prices would skyrocket more than 70% to $150 per barrel from just under $90 we have now.

An estimated 20-30% of global oil supply passes through the Strait of Hormuz, which is controlled by Iran. If Iran were to get directly involved in the war, there would be increased pressure for the US and other Western nations to increase sanctions on Iran, which could then turn around and close the strait, disrupting global oil supplies and elevating prices.

Bloomberg does not think the impact on oil prices would be as severe as the quadrupling seen during the "Oil Shock" in 1973 when Arab states imposed an embargo in retaliation for US support of Israel during the Yom Kippur War. However, they believe it could be in line with the surge seen after Iraq invaded Kuwait in 1990, but with a much higher starting point this time around.

The impact would be enormous

A price of $150 per barrel would be the highest in over a decade.

Bloomberg's economists surmise that such a surge in oil prices alone could cause global GDP growth to fall from the 3.0% predicted for 2023 to 1.7%, a drop in about $1 trillion of world output.

If oil prices do surge, inflation could spike again in the US, as they directly impact gas prices for the American consumer to fill their cars and travel on planes. It would also raise the cost of shipping goods, affecting supply chains and causing prices to soar.

As the US continues its fight against inflation, former US Treasury Secretary Steven Mnuchin called oil prices the big mystery in the US economy's short-term future, during a Friday interview on Fox Business' "Kudlow." He noted that the Fed is "close to done" hiking interest rates, but they will likely remain high well into 2024 and warned things could get rocky if Middle East tensions escalate even higher.

"There's no question that long-term interest rates have risen significantly, also that's going to help the Fed's job. That's going to slow down the economy," Mnuchin said. "I think there is going to be risk pressure against equities as the US economy slows down, and the big unknown is what happens to oil prices if the situation in the Middle East continues to escalate."

The answer might be in the US

While US oil production recently hit a record high of 13.2 million barrels a day, Mnuchin called on the US to boost its ouput of oil even higher. He said the fight against climate change should take a backseat for now and national security should take precedence.

"We need to increase domestic production," Mnuchin said. "We have plenty of capacity here. We have both capacity for oil. We have capacity for natural gas. There is a time for climate change and to be worried about that, but right now, these are national security issues, and we should make sure the US has plenty of energy to supply ourselves and supply our allies."

Raising oil production would go against the Biden administration's push for green energy. However, complicating matters is that the US Strategic Petroleum Reserve is near a 40-year low. The Biden administration unloaded 180 million barrels last year to help counter the price surge following the Russian invasion of Ukraine.

With fewer barrels in reserve, there's now less oil the US can release into the economy and help increase supply and thus lower prices.

Now the US wants to refill the Strategic Petroleum Reserve, but the government could be facing another round of price hikes at the pump and a lot less in its reserve to help. While the already record level of domestic oil production helped offset OPEC+ cuts, it would be a formidable task to fight a new round of price hikes and refill the reserve.

When the Fed paused rate hikes in September for the first time in 15 months, Chairman Jerome Powell was asked if a soft landing had become a baseline expectation.

While he said it was possible, he warned that "ultimately, this may be decided by factors that are outside our control at the end of the day."