Iran Conflict Fuels Energy Shock with Far-Reaching Impacts

The ongoing war in Iran has caused global energy markets to grapple with a supply-driven shock that's fundamentally different from typical commodity price spikes.

Western Canadian energy assets are among the most attractive globally, thanks to their low reliance on the Strait of Hormuz and stable jurisdiction. Companies like Canadian Natural Resources and Tourmaline Oil have generated significant free cash flow in this environment, with share prices predictably strong but not as high as oil prices due to a stronger Canadian dollar.

The situation is complicated by macro uncertainty, currency dynamics, and the length of the disruption. Historically, Canada's heavy oil has traded at a discount to American light sweet crude due to quality differences and transportation costs. However, the Trans Mountain pipeline expansion has allowed more supply to be shipped through Pacific ports, shrinking this discount.

The energy shock has secondary effects beyond the price at the pump. Higher energy prices will impact raw material costs for cement, steel, transportation, and freight, as well as consumer products. This is particularly concerning for food production, where natural gas is a primary feedstock for ammonia fertilizer. If gas prices stay elevated, fertilizer plant curtailments could lead to higher food costs.

The base case for markets is that the conflict resolves within a few months, with oil prices stabilizing between $70-$80. This range is also seen as a permanent new floor by commodity houses. Under this scenario, inflation will be meaningful but manageable.