Wildcards of 2025

The interplay between energy and geopolitics has historically defined global alliances, economic stability, and power structures, evolving into an increasingly complex nexus in the twenty-first century. Historically, access to energy resources has shaped the outcomes of wars, forged alliances like OPEC, and enabled nations to wield energy as a strategic tool.

Today, this dynamic is influenced by emerging energy resources, evolving global demand patterns, the rise of climate-focused policies, and diversified supply chains. These developments present both opportunities and risks, compelling policymakers and industries to navigate a more volatile and interconnected global energy landscape.

The United States, as a leading hydrocarbon producer and exporter, occupies a central role in this energy-geopolitics nexus. Its energy abundance grants it substantial leverage in global markets, positioning energy as a key instrument of national security.

However, this leverage poses critical questions: How, when, and to what extent should energy be deployed to achieve foreign policy objectives?

History reveals that the strategic use of energy often produces unintended consequences, such as market disruptions, economic instability, or geopolitical backlash, underscoring the need for careful calibration of policy interventions.

The relationship between geopolitical developments and oil prices remains complex and far from predictable, as the impact of geopolitical events often proves to be short-lived and influenced by broader market forces. While high-profile events such as wars, terrorist attacks, and political tensions can cause immediate price volatility, the effects typically dissipate quickly.

For example, after the 9/11 attacks, Brent crude prices rose by 5% before falling 25% within two weeks due to demand concerns. Similarly, Brent prices surged nearly 30% in the immediate aftermath of Russia's 2022 invasion of Ukraine but reverted to pre-invasion levels within two months. More recently, after the October 2023 terrorist attacks in Israel, Brent crude saw a brief 4% rise before stabilizing.

A broader analysis using the Caldara and Iacoviello (2022) global geopolitical risk (GPR) index, which measures geopolitical tensions through global news coverage, underscores the lack of a systematic relationship between geopolitical shocks and sustained oil price increases or volatility. Major spikes in the index, such as during the Ukraine conflict or heightened Middle Eastern tensions, have not consistently resulted in prolonged oil price disruptions. This highlights that while geopolitical risk often acts as a catalyst for short-term market fluctuations, structural market fundamentals—such as global supply-demand balances, inventory levels, OPEC+ strategies, and macroeconomic trends—are more significant drivers of long-term price movements.

Geopolitical risk, defined as the threat, realization, or escalation of adverse events associated with wars, terrorism, or state-level tensions, poses broader implications for financial stability. Geopolitical risks could magnify the trend of geopolitical fragmentation—the reversal of global economic and financial integration due to geopolitical considerations—which could have far-reaching implications for investment flows, supply chains, and long-term economic growth.

Recent events, including conflicts in the Middle East, escalating U.S.-China tensions over Taiwan, and the ongoing war in Ukraine, have raised concerns about geopolitical stability. Adverse geopolitical developments can trigger sharp shifts in market sentiment, leading to increased uncertainty and exposing vulnerabilities in financial markets and institutions. These events often reduce consumption and investment activity, slowing economic growth and exacerbating adverse feedback loops between the real economy and financial systems.

Brent crude oil price and GPR Index since 1970

Geopolitical risk exerts a significant negative influence on the global economy by amplifying uncertainty, undermining investor and consumer confidence, and slowing economic growth. Adverse events—such as conflicts, sanctions, or heightened political tensions—can disrupt international trade, impose stricter barriers, and destabilize supply chains and commodity markets. Historical examples, such as the oil shocks of the 1970s driven by geopolitical tensions in the Middle East, illustrate how these disruptions can lead to economic stagnation, inflation, and volatility in financial markets.

Transmission channels of geopolitical risk to financial stability

In today’s interconnected global economy, the effects of geopolitical risk extend across multiple dimensions. On a macroeconomic level, geopolitical shocks can dampen GDP growth, reduce trade flows, and constrain both consumption and investment. For financial markets, these risks drive capital flow volatility, impact asset prices, and introduce uncertainty into commodity markets, particularly energy. These disruptions create adverse feedback loops between the real economy and financial sectors, affecting the ability of banks and non-banks to maintain funding, lending, solvency, and profitability.

Geopolitical shocks impact oil prices through two primary channels: the economic activity channel and the risk channel, each exerting opposing pressures on the market.

• The economic activity channel reflects the negative demand shock caused by heightened geopolitical tensions. Increased uncertainty about the global economic outlook dampens consumption, investment, and international trade, leading to lower economic activity and, consequently, reduced oil demand and downward pressure on prices.
• Conversely, the risk channel captures the financial market’s response to perceived supply risks, as geopolitical shocks may prompt investors to price in higher future supply disruptions. This increases the convenience yield—the premium for holding oil contracts—and puts upward pressure on prices.

Empirical evidence suggests that the economic activity channel often dominates, resulting in downward pressure on oil prices following geopolitical shocks. For example, using a Vector Autoregression (VAR) model that accounts for oil producer responses, global economic activity, and financial cycles, Brent price responses to geopolitical shocks were analyzed for the period from January 2000 to October 2023. The analysis, employing Bayesian methods, shows that oil prices initially remain stable after a geopolitical shock, as elasticity in the short term is negligible. However, over the following quarter, Brent prices decline by approximately 1.2%, suggesting that the contraction in global economic activity outweighs supply risk concerns. This pattern was observed after major geopolitical events such as the 9/11 attacks, where higher uncertainty led to a weakening of oil demand rather than sustained upward price pressures.

The analysis reveals that while energy remains a powerful geopolitical tool, its strategic use requires careful calibration to avoid unintended consequences such as market disruptions and economic instability. Historical patterns, as well as empirical evidence, emphasize the importance of considering both short-term catalysts and long-term fundamentals when navigating the volatile nexus of energy and geopolitics.

As we move further into 2025, the global energy landscape is set to become even more volatile, driven by rising geopolitical fragmentation, emerging market demand, and the increasing influence of climate-focused policies. For policymakers, investors, and industries, understanding the interconnected nature of these factors is crucial. Whether it’s managing the risks of U.S.-China competition, adjusting to Trump’s energy policies, or responding to shifts in global supply chains, navigating this landscape requires agility, informed strategy, and a keen awareness of the big picture.