The Lasting Impact of the Persian Gulf War

The Real Estate Espresso Podcast

The Lasting Impact of the Persian Gulf War

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The Lasting Impact of the Persian Gulf War

Welcome to the Real Estate Espresso Podcast, your morning shot of what’s new in the world of real estate investing. I’m your host, Victor Menasce.

On today’s show, we’re talking about the lasting impact of the war in the Persian Gulf on oil prices and, more importantly, the cascading effects on real estate here in the United States and Canada.

When conflict broke out in the Persian Gulf, the first reaction in financial markets was almost automatic: bid up the price of oil. That response is understandable. A large portion of the world’s seaborne crude passes through the Strait of Hormuz, and any threat to that supply got reflected in price almost instantly.

But here’s where we need to separate headlines from the economic reality. A spike in oil prices does not affect every form of energy equally. In the US, natural gas is largely a domestic market. It has its own supply dynamics, its own pipeline network, and its own storage system. So even if crude oil jumps dramatically because of geopolitical tensions, natural gas in the US may hardly move.

In fact, even if the global price for natural gas was to spike, the domestic price is hardly going to be affected at all. See, the US only exports about 20% of its natural gas production, and that percentage is limited by the capacity of the existing LNG plants. The gas export may get a good price, but the gas that remains domestically in the United States is still going to be at the Henry Hub price, and it will be at a significant discount compared to the global price.

When all of the LNG plants under construction are completed, the percentage of US production available for export might increase to 30% and then maybe, in the long term, eventually 40%, but that’s years and possibly decades away.

The same is true for electricity prices in many parts of the country. Electricity rates are influenced by generation mix, meaning what’s the source; regulation; the local utility structure; and long-term power contracts. If a region gets more of its electricity from natural gas, nuclear, hydroelectric, coal, these prices remain stable. Then retail electricity prices are probably not going to notice the shock in oil prices at all.

So where will we see the impact? We will see it first in transportation. Diesel prices matter enormously, and diesel is the fuel of the real economy, certainly for transportation. It moves construction materials, food, appliances, equipment, steel, lumber… all of these things in the world of construction are driven by diesel. And if diesel rises meaningfully, the cost of moving those goods rises with it.

That affects construction sites, distributors, warehouse operators, every supplier feeding the construction environment. Now, that increase may not be dramatic. Sometimes it appears as a series of small increases: freight surcharges, delivery fees, longer lead times, higher minimum order quantities, less willingness by suppliers to hold pricing for more than 30 days.

This is one of the reasons developers need contingency in their budgets. It’s not enough to model direct materials and labour. You need to model that friction. Oil shocks create friction throughout the supply chain.

The second place you’ll see the impact is in petrochemical products. A surprising number of building materials either come from petroleum or depend on petroleum manufacturing. Think about roofing, roofing tiles, insulation, PVC pipe, flooring adhesives, sealants, paints, resins, plastics. These all have linkages to hydrocarbons.

So that means that if your power bill is unchanged, the cost of constructing or renovating a home still can rise. Not because of electricity, but because the materials themselves become more expensive to produce or transport.

The third is consumer behaviour. When households spend more at the pump, they have less money available for everything else. It doesn’t hit every asset class the same way. Workforce housing tends to be a bit more resilient than discretionary retail. Grocery-anchored retail is probably going to hold up better than lifestyle centers. Industrial that’s supplying essential distribution can remain strong, but hospitality can definitely feel the pinch as families cancel road trips or cut their travel budgets.

United Airlines has already started cutting routes, especially long-haul routes, from now out to the end of the year. Specifically, they’re reducing the frequency of service on some of these long-haul routes.

If your tenants are highly sensitive to commuting costs, suburban properties in a car-dependent market might feel the pressure. If your project depends on visitors driving long distances, demand might be weaker. If your building serves local necessity-based demand, the effect is going to be much smaller.

We saw this last in a significant way in 1973 during the Arab oil embargo. What precipitated from that was a wage-price spiral that took years to settle down.

The biggest mistake that central bankers are likely to make is to advocate for higher interest rates in order to fight inflation. The fact is, inflation is not the product of an overheated economy. Raising interest rates would slow down economic growth by dampening demand. But we’re not seeing prices rise as a result of excess demand. We’re seeing prices rise because the regime in Iran has closed the Strait of Hormuz. Raising interest rates is not going to reopen the Strait of Hormuz.

It’s almost as if central bankers have only one tool. Whether that tool is effective or not against solving the problem is completely immaterial. It’s almost as if you go to the doctor in the morning with a headache, and the doctor then hits you in the thumb with a hammer and asks you if your head still hurts.

Energy is embedded in every single supply chain in every single aspect of the economy. You’ll see it in diesel and freight and construction and consumer disposable income. You’ll see it in commuting-sensitive locations. You might even see it in lender behavior because cost of capital goes up. And while you might not see it in US natural gas, or you might not see it in retail electricity prices, you’ll absolutely feel it in the physical economy.

As you think about that, you want to ask yourself a very simple question: Does your portfolio have enough resilience to handle a world where transport costs rise, where consumer sentiment runs negative, and where capital becomes more selective?

And in the meantime, have an awesome rest of your day. Go make some great things happen. We’ll talk again tomorrow.

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