War and Energy: How Conflict Rewires Global Markets

Why This Matters Now

The global security environment in 2026 contains more active and potential conflict zones intersecting with energy infrastructure than at any point since the Second World War. The Russia-Ukraine conflict continues to disrupt European energy security. Middle East tensions span multiple flashpoints including Iran's nuclear program, Houthi attacks on Red Sea shipping, and the broader Sunni-Shia strategic competition. South China Sea territorial disputes overlay the world's busiest shipping lanes. Each of these theaters independently carries the potential for energy supply disruption. Their simultaneous activity creates correlation risk that markets have consistently underpriced.

The Stockholm International Peace Research Institute (SIPRI) reported in its 2026 Yearbook that global military expenditure reached $2.4 trillion in 2025, the ninth consecutive year of increase. Arms transfers to the Middle East increased by 25% over the 2020 to 2025 period. The number of state-based armed conflicts reached 56 in 2025, the highest level since records began in 1946. This militarization trajectory makes energy supply disruption scenarios more probable, not less, even as financial markets price geopolitical risk at historically compressed levels.

This article analyzes how armed conflict transmits to energy markets and from energy markets to the broader financial system. It examines three active and three potential conflict scenarios, quantifying the supply disruption and price impact of each. The analysis draws on historical precedent, current military capabilities assessment, and institutional research from the IEA, BIS, and major central banks.

The Conflict-Energy Nexus: Historical Patterns

The relationship between armed conflict and energy prices is not merely correlational but mechanically causal. Energy infrastructure, particularly oil production facilities, refineries, pipelines, and shipping lanes, represents both strategic targets and economic centers of gravity. Attacking or controlling energy infrastructure is simultaneously a military objective (denying resources to the adversary) and an economic weapon (imposing costs on the adversary's economy and its allies).

The 1973 Arab-Israeli War established the modern template for conflict-driven energy disruption. The OPEC oil embargo, deployed as an economic weapon against nations supporting Israel, reduced global supply by approximately 5 million barrels per day, roughly 9% of global consumption. Prices quadrupled from $3 to $12 per barrel. The economic impact was devastating: US GDP contracted 3.2% in 1974, unemployment doubled, and inflation reached 12.2%. The embargo demonstrated that energy supply could be weaponized, transforming oil from a commodity into a strategic instrument of state power.

The 1980 Iran-Iraq War removed approximately 4 million barrels per day from global supply as both belligerents targeted each other's export infrastructure. Iranian oil production fell from 5.5 million barrels per day to 1.5 million. Iraqi production fell from 3.5 million to 0.9 million. Prices, already elevated from the 1979 Iranian Revolution, remained above $35 per barrel for three years. The Tanker War phase (1984 to 1988), during which both sides attacked commercial shipping in the Persian Gulf, established the precedent for maritime energy supply disruption that remains relevant to current Red Sea and Strait of Hormuz scenarios.

The 1990 Gulf War demonstrated rapid supply disruption followed by rapid recovery. Iraqi invasion of Kuwait removed 4.3 million barrels per day (Kuwait's 2 million plus Iraq's 2.3 million under sanctions) from global markets. Prices spiked from $17 to $41 within weeks. However, Saudi Arabia increased production by 3 million barrels per day within 90 days, and the military liberation of Kuwait in early 1991 restored pre-invasion supply within six months. The key lesson: the speed and credibility of the supply response determines the duration of the price impact.

The 2019 Abqaiq-Khurais attack represents the modern asymmetric warfare template. Drone and cruise missile strikes on Saudi Aramco processing facilities temporarily removed 5.7 million barrels per day of production, approximately 5% of global supply. This was the single largest supply disruption event in history, exceeding the 1973 embargo in absolute terms. Prices spiked 15% in a single trading session. However, Saudi Arabia's rapid repair response (full production restored within two weeks) and the absence of follow-on attacks meant the price impact was transitory. A sustained campaign of such attacks would produce fundamentally different market outcomes.

The Strait of Hormuz: The Single Point of Maximum Vulnerability

The Strait of Hormuz is the most consequential energy chokepoint on Earth. This 21-mile-wide passage between Iran and Oman carries approximately 17.3 million barrels per day of crude oil and petroleum products, representing roughly 20% of global oil consumption and 25% of global liquefied natural gas (LNG) trade. There is no alternative routing for the majority of this volume. Saudi Arabia's East-West pipeline can divert approximately 2 million barrels per day to Red Sea export terminals, and the UAE's Habshan-Fujairah pipeline can move 1.5 million barrels per day, but these bypass routes cover less than 25% of total Hormuz flows.

Iran possesses credible capabilities to disrupt, though not permanently close, the Strait. The Islamic Revolutionary Guard Corps Navy (IRGCN) maintains a fleet of fast attack craft, shore-based anti-ship missiles (including the Khalij-e Fars ballistic anti-ship missile with 300km range), and mine warfare capabilities. Iran's mine inventory is estimated at 3,000 to 5,000 mines of various types, including modern influence mines that are difficult to sweep. The US Navy's mine countermeasures capability, while formidable, requires 30 to 60 days to clear a minefield of this scale, during which shipping insurance rates would make transit economically prohibitive.

The insurance channel is the most underanalyzed aspect of Strait of Hormuz risk. Lloyd's of London and the international marine insurance market set war risk premiums that directly affect shipping economics. During periods of elevated tension, war risk premiums for Persian Gulf transits have reached 1 to 2% of hull value, adding $500,000 to $2 million per voyage for Very Large Crude Carriers (VLCCs). If war risk premiums reached 5% of hull value, consistent with an active conflict scenario, the additional cost would exceed $5 million per voyage, effectively pricing many operators out of the route. This de facto closure through insurance markets could achieve Iran's strategic objective without a single shot being fired.

Red Sea and Bab el-Mandeb: The Active Theater

Unlike the Strait of Hormuz, Red Sea disruption is not a hypothetical scenario but an ongoing reality. Houthi attacks on commercial shipping, which began in November 2023 and intensified through 2024 and 2025, have fundamentally altered the economics of Red Sea transit. Approximately 12% of global trade passes through the Red Sea, including 7 million barrels per day of oil and petroleum products.

The shipping industry's response has been to reroute around the Cape of Good Hope, adding 10 to 14 days to Europe-Asia transit times and increasing voyage costs by $1.5 to $2.5 million. For oil tankers, this rerouting adds approximately $2 to $4 per barrel to delivered crude costs, a persistent cost increase that transmits to consumer prices. Container shipping rates for the Asia-Europe route have increased by 200 to 300% from pre-disruption levels, with cascading effects on consumer goods prices.

The strategic implications extend beyond direct cost increases. Red Sea disruption has exposed the fragility of just-in-time supply chains and the absence of viable alternative routing for many trade flows. European refineries configured to process Middle Eastern crude face particular challenges, as alternative supplies from the Atlantic Basin come at higher freight costs and different crude quality specifications. The European Petroleum Refiners Association estimated in its 2025 Annual Report that Red Sea disruption added EUR 3 to 5 per barrel to European refining costs, contributing to persistently elevated fuel prices across the continent.

Russian Supply: Sanctions, Shadow Fleets, and Escalation Risk

Russia's 7.5 million barrels per day of crude exports represent the largest single-country supply risk in the current market. Western sanctions, including the EU import ban and G7 price cap at $60 per barrel, were designed to reduce Russian oil revenue without removing Russian supply from global markets. This calibrated approach has partially succeeded: Russian crude continues to flow, primarily to China and India, but at a $10 to $15 discount to Brent benchmark.

The shadow fleet that facilitates Russian oil exports has grown to approximately 600 vessels, representing roughly 10% of the global tanker fleet. These vessels operate with non-Western insurance, often from jurisdictions with limited regulatory oversight. The environmental and safety risks are substantial: aging vessels with deferred maintenance carrying crude oil through environmentally sensitive waters. A major spill from a shadow fleet tanker would trigger both environmental and regulatory responses that could tighten enforcement of the existing sanctions framework.

Escalation scenarios that could remove substantial Russian supply from global markets include: secondary sanctions enforcement that targets Chinese and Indian purchasers (removing 3 to 4 million barrels per day from accessible markets), military damage to Russian export infrastructure (Druzhba pipeline, Baltic and Black Sea terminals handle over 5 million barrels per day combined), or a negotiated settlement that includes enhanced sanctions verification. Each of these scenarios carries significant probability in the current geopolitical context and would produce immediate and substantial price effects.

Capital Flow Redirection During Conflict

Armed conflict redirects capital flows through predictable channels. Risk-off positioning drives capital from emerging markets to safe-haven assets, typically US Treasuries, German Bunds, Swiss francs, gold, and Japanese yen. Equity markets in conflict-affected regions experience outflows, while defense sector equities and commodity producers attract inflows. The net effect is a tightening of financial conditions in precisely the economies most vulnerable to energy price shocks.

The Institute of International Finance tracked capital flows during four recent conflict episodes. The 2022 Ukraine conflict triggered $83 billion in emerging market outflows in Q1 2022 alone, the sharpest quarterly reversal since the 2020 pandemic. The 2023 Israel-Hamas conflict produced $12 billion in Middle East outflows over six weeks. The 2024 Red Sea escalation triggered an additional $8 billion in outflows from Gulf state bond markets, despite these economies being net beneficiaries of higher oil prices.

For portfolio managers, the capital flow pattern creates a specific risk-return profile during conflict-driven energy shocks. Energy equities and commodity producers typically outperform for 3 to 6 months following the initial shock, but then underperform as demand destruction and recession expectations weigh on forward earnings. Government bonds initially rally on safe-haven flows but then sell off as inflation expectations rise and central banks signal tightening. Gold exhibits the most consistent positive performance across all conflict episodes, with average returns of 12 to 18% in the 12 months following a major geopolitical shock.

Financial System Impact: How War Reprices Everything

Armed conflict reprices financial assets through three simultaneous channels: fundamental value revision (changed earnings and cash flow expectations), risk premium expansion (higher required returns for bearing uncertainty), and liquidity withdrawal (reduced willingness to provide market depth during uncertainty). The convergence of these channels during a major conflict-driven energy shock creates market conditions characterized by elevated volatility, widened spreads, and reduced trading volumes.

Credit default swap spreads for energy-importing sovereign borrowers provide a real-time gauge of conflict transmission. During the initial phase of the Ukraine conflict, CDS spreads for Turkey widened from 400 to 850 basis points, for Egypt from 550 to 1,200 basis points, and for Pakistan from 1,500 to 3,500 basis points. These spread movements represented a repricing of sovereign default risk that directly affected borrowing costs, capital flows, and domestic financial conditions in each country.

The derivatives market creates both hedging opportunities and systemic risk during conflict-driven commodity shocks. The London Metal Exchange's decision to cancel $3.9 billion in nickel trades during the 2022 price spike demonstrated that exchange-level circuit breakers can themselves become sources of market stress. Commodity futures margin requirements typically increase by 50 to 100% during extreme price moves, forcing leveraged participants to liquidate positions, which amplifies the price volatility that triggered the margin increase. This procyclical dynamic is a structural vulnerability in financialized commodity markets that cannot be eliminated through regulation alone.

Solutions and Strategic Responses

Strategic responses to conflict-driven energy risk operate at three levels: international coordination, national policy, and institutional-corporate adaptation. International coordination through the IEA's collective action mechanism provides the primary structured response. The IEA's 31 member countries hold aggregate strategic reserves of approximately 1.5 billion barrels and have demonstrated the ability to coordinate releases within 48 hours of a supply disruption event. However, the political decision to release reserves has historically lagged the market impact by days to weeks, reducing the effectiveness of the intervention.

National policy responses include accelerating energy transition investments, diversifying supply sources through long-term contracts with non-conflict-exposed producers, and building domestic strategic reserves. Japan's model, maintaining 270 days of oil import coverage through a combination of government and private sector reserves, represents the gold standard. Most nations maintain far less, with the OECD average at approximately 85 days.

Corporate and institutional responses center on energy procurement hedging, supply chain diversification, and scenario planning for disruption events. Companies with forward hedging programs covering 60 to 80% of anticipated energy consumption have consistently outperformed unhedged competitors during price shocks. The cost of hedging, typically 3 to 5% of notional value through options strategies, is modest relative to the potential cost of unhedged exposure to a 100 to 150% price increase.

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