Impact of the Iran Conflict and Rising Oil Prices on the Construction Sector

By BEN JOHNSTON

The war with Iran has effectively closed the Strait of Hormuz and forced producers in the Gulf region to begin shutting down oil and gas production, actions that cannot be quickly reversed.

Given that approximately 20 percent of the world’s oil production must travel through the Strait of Hormuz in order to reach businesses and consumers, it is likely that this disruption will be significant, and last for weeks or months, depending on the duration of hostilities and the time it takes to reestablish production and a working supply chain once the war is over.

The construction industry has significant exposure to the petroleum markets given the heavy machinery used during the construction process and the building materials required in modern construction.

In addition to oil and gas, Gulf states also export a range of products critical to support the global construction industry such as aluminum, steel and concrete.

Broader Economic Picture

Rising oil prices are yet another shock to operating margins that small businesses in the construction sector need to contend with. Nearly a year ago, small construction businesses were contemplating the impact of “Liberation Day” tariffs imposed on nearly all of our trading partners.

Over the course of the year, construction businesses learned how to navigate these tariffs, altering supply chains and onshoring as much production as possible in an effort to avoid the tariff’s most painful effects.  At the same time, businesses grappled with improving, yet stubbornly high, inflation and interest rates which combined to further reduce margins.

Today, with oil climbing above $100 per barrel, small construction businesses are once again grappling with the impact of an unforeseen expense and agonizing over whether to pass these increased costs on to an already stretched customer base.  We expect that businesses will likely delay raising prices as long as possible – similarly to when tariffs were first introduced – but that businesses will ultimately need to pass these expenses on to customers should prices remain elevated for several months.

The uncertainty caused by a sudden spike in oil prices and the lack of clarity as to the severity and duration of the spike will likely cause many small construction businesses to retrench, holding off on starting new projects, taking on new hires and investing in the growth of the business, until the picture becomes clearer.

Other Industries Impacted by These Disruptions

One of the industries with the highest dependency on oil and gas prices is the transportation industry which includes long-haul trucking as well as short-haul and local delivery services. Fuel oil is one of the transportation industry’s primary operating expenses, and operators will feel the impact of this disruption immediately.

The agriculture industry is also highly exposed given the diesel-powered heavy machinery used in production, the distribution costs required for products to reach consumers and the fertilizer required to maintain crop yields.

Many small manufacturers also have significant exposure as oil and gas are often used directly in the manufacturing process or to generate electricity to power plants and equipment or in the production of raw materials such as plastic, aluminum and steel.

On the Positive Side

The U.S. has a robust oil and gas industry which employs many small businesses involved in both upstream and downstream production. These businesses will benefit from higher prices which, if sustained for a long enough period of time, make additional oil and gas projects economically viable. It is also important to note that as the largest oil and gas producer in the world, the United States is less exposed to economic disruption than many other developed economies, especially those in Europe and Asia.

As a result, it is likely that fuel costs will rise higher and faster in parts of the world where we are currently levying tariffs with the goal of driving production back to the United States. If U.S. oil prices become a relative advantage to U.S. businesses, it may serve to speed the repatriation of manufacturing back to the U.S. during this period of instability.

Financial Strategies for Small Construction Business to Stay Resilient Against Sudden Economic Shocks

Over the past several years, small construction businesses have become all too adept at managing through crises. Many have learned the hard way the importance of keeping a close eye on margins, managing supply chains and cost of goods.  Successful construction businesses today maintain options in their supply chain, their headcount and in their access to capital. Many businesses today are investing in automation as a way to control more of their supply chain and reduce dependency on human capital. With recent advances in AI, many businesses are now adopting AI tools that help them connect with and manage customers, handle accounting and business analytics.

Successful construction businesses also maintain multiple financial relationships capable of providing working capital to fund growth. Many also finance equipment purchases and maintain revolving lines of credit to manage the volatility of cashflows month to month.

It is important for small construction businesses to maintain both bank and non-bank relationships to ensure access to a full suite of financial products.

Ben Johnston is COO of Kapitus, a small business lender and marketplace.