Geopolitical Shock Transmission and Time-Varying Correlations in Energy Markets: Evidence from the 2025 to 2026 Iran Conflict Episodes
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Abstract
This paper examines how two Iran-related geopolitical shocks of markedly different severity restructure the correlation and volatility architecture of energy markets. Using daily return data for Brent and WTI crude oil futures alongside five major international oil company equities, namely ExxonMobil, Chevron, BP, Shell, and TotalEnergies, 482 trading-day observations spanning January 2024 through March 2026 are analyzed through a Dynamic Conditional Correlation GARCH framework complemented by GJR-GARCH conditional volatility estimation and the Diebold-Yilmaz directional spillover approach. The study encompasses four analytically distinct sub-periods: a pre-conflict baseline, the contained Israel-Iran 12-Day War of June 2025, an inter-shock calm phase, and Operation Epic Fury, the sustained US-Israeli military campaign beginning February 2026 that produced the first confirmed Strait of Hormuz disruption in four decades. Key findings reveal that the Brent-WTI correlation surges from 0.26 in the baseline to 0.85 during Operation Epic Fury, a shift confirmed statistically significant at p less than 0.01 via Fisher Z-transformation, while the S&P 500-Brent correlation inverts from positive 0.10 to negative 0.75, providing a textbook supply-shock signature. Brent conditional volatility triples from 31.6 percent to 102.3 percent annualized, whereas energy equity volatility remains effectively unchanged, exposing a structural decoupling between commodity and equity markets during sustained physical disruption. Brent functions as the dominant spillover transmitter, explaining 27 to 32 percent of the forecast error variance of all energy equities, with WTI directional transmission intensity surging sharply during Operation Epic Fury as the US benchmark reprices its secondary Hormuz exposure. The Brent-WTI price spread widens from a pre-conflict mean of USD 4.11 to USD 10.73 per barrel, reflecting differential geographic exposure to seaborne Middle East crude supply. These findings carry direct implications for dynamic hedging, portfolio risk management under geopolitical supply shocks, and systemic energy market stress monitoring by financial stability authorities.
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