Thursday, two Israeli soldiers were killed by a Palestinian mob, prompting sweeping retribution by Israeli helicopter gunships in Palestinian strongholds. Meanwhile, in an apparent terrorist attack, an explosives-laden boat rammed a U.S. Navy destroyer in a Yemeni port, killing at least seven U.S. sailors and 10 are still missing and presumed dead.

Thousands of miles away on a sliver of pricey real estate in lower Manhattan, traders furiously sent the price of oil soaring to perilously high levels and frantically sold off U.S. stocks.

Why is the flurry of tragic events in the Middle East the catalyst for such turmoil and uncertainty in energy and stock markets in the U.S.? Does the further erosion of the imperiled Mideast peace process spell crisis for oil and the U.S. economy, or are the markets overreacting?

Aside from the obvious threat to peace in the Middle East, the potential danger to sources of oil in the region puts pressure on an already critical energy situation in the U.S. There are now fears that rising violence could imperil the region's oil production at a time when U.S. energy supplies are already running low. This, in turn, has a broad-based impact on the U.S. economy and the majority of U.S. stocks, because many companies rely on fuel to deliver their products to customers, or on energy to manufacture their goods.

But the reaction to the situation in the Middle East hinges mostly on speculation -- speculation that Israelis and Palestinians will erupt in war, which may potentially involve (directly or indirectly) oil-producing nations in the region and the U.S. The market is factoring in a possibility of problems associated with oil in the future. Given the uncertainties, it's worth examining why the market responds with such fear and some of the potential flashpoints that may erupt if the crisis worsens.

The Impact on Oil Prices

From an oil standpoint, the chaos in Israel couldn't have happened at a worse time. In September, oil prices hit a 10-year high of $38 a barrel, prompting

President Clinton

to release emergency stockpiles to ease prices.

However, this was largely a politically symbolic gesture because the reserves aren't enough to supply the U.S. economy for a sustained period, so any good feeling from the emergency stockpiles has already dissolved, says Corey McElveen, an oil-industry analyst at

Morningstar

. The worry now is that oil prices will continue to soar -- benchmark crude futures surged $2.83 to $36.08 yesterday -- as the major oil-producing nations in the

Organization of Petroleum Exporting Countries

that are sympathetic to Arab issues would use productivity to make a statement to the U.S., he says.

This is especially problematic because, according to industry experts, Saudi Arabia and the United Arab Emirates are the only OPEC nations with excess capacity at present. Further complicating matters is the fact that Iraq's influence on the region and the world's oil market is the strongest it has been in the post-Gulf War era.

Under the scenario discussed by McElveen, oil and energy prices would remain high for at least the rest of the winter, economists and Wall Street watchers say. The high cost will have a broad impact on U.S. business. Energy remains a vital component for many companies, from semiconductor-equipment makers who use fuel to make plastic components to energy-intensive industrial concerns. High oil costs also devastate airlines and other transportation companies. As the cost of energy increases, even companies lower down on the food chain, such as those in the service and technology sectors, could feel the chill.

Your Pocketbook and Portfolio

In addition to making oil prices so high that you might choose to skip the 200-mile drive to grandmother's house for Thanksgiving, conflict in the Middle East may inflict much pain on your stock portfolio. There is the potential for a protracted conflict that erodes U.S. relations with OPEC nations and spurs skyrocketing oil prices to lead to a sharp economic slowdown and an attendant market decline.

There are two major areas where investors could immediately see the ripple effects, and predictably they will be related to the potential high cost of oil. Companies that rely on energy to manufacture their products, especially heavy industry, could see their already-tight margins squeezed, says Justin Craib-Cox, a stock analyst at Morningstar. A good example is

DuPont

(DD) - Get Report

, which has already said it will see a loss in earnings due to its exposure to Europe. The impact of oil prices will have further effect, he says.

For technology and services companies there is a less obvious, but still-pronounced impact, says Craib-Cox. The high cost of oil could cause an economic slowdown, and that will mean less capital spending by fast-growing tech and telecom companies, and that's what keeps the economy going. "You need to look at companies and ask how recession-proof they are," he says. "If the economy slows, what does that do to the company's product? Is a company resilient, or is it a technology company that relies on a strong economy to sell its product?"

Also in danger are those companies that have a significant exposure to fuel costs, says McElveen. Transportation companies are in for a rough ride, as are the major airlines. The cost of fuel could be passed on to the consumer in the form of more expensive ticket prices and fuel surcharges, McElveen says. Indeed, the major airlines increased fuel surcharges this month and raisedticket prices for the fifth time this year. Even oil refineries might try to pass on their costs to consumers, he adds. "There is a ripple effect that is concerning economists. The higher cost of products could push up inflation."

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From a market perspective, there are some potential winners. Big oil companies like

BP Amoco

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and

Exxon Mobil

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stand to gain from high oil prices, as a more limited availability of oil means these companies can ramp up drilling and exploration. Also, companies involved in the exploration and refining of oil, such as

Halliburton

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and

Schlumberger

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, stand to gain.

The Background

As an integral part of the U.S. economy, oil prices and the country's reliance on imports from countries on geopolitical fault lines have been recurring, looming concerns for U.S. businesses and investors.

The 1970s energy crisis had a crippling effect on the U.S. economy; it stemmed in part from Arab nations instituting an oil embargo to voice their displeasure of U.S. support of Israel in the 1973 Middle East war. More recently, oil prices escalated leading up to and during the 1991 Gulf War. Still, while the U.S. may not be as vulnerable to oil prices today, energy remains a vital component of the economy. Crude oil provides about 40% of the energy Americans consume, and 97% of the nation's transportation fuels, according to the

American Petroleum Institute

.

For now, OPEC says it intends to get crude oil prices back within their informal price band of $22 to $28 a barrel. On Oct. 1, OPEC raised its production ceiling to 26.2 million barrels daily to rein in runaway oil prices. When inventory is low the U.S. can still function, but the economy is more vulnerable to disruptions in the flow of oil, such as damages to pipelines or oil rigs, says Mike Conner, an analyst at the

National Energy Information Center

in Washington, D.C.

Best Case/Worst Case Scenarios

Of course, the best-case scenario -- which is looking increasingly unlikely -- is a resumption of peace talks, with perhaps a unified Israel cabinet including Ariel Sharon, the hawkish leader of the opposition Likud party. President Clinton pledged to continue efforts for peaceful negotiations, but administration officials acknowledged that near-term prospects for a hopeful resolution are imperiled. Any inroads on the peace front would have a calming influence on the markets. Market participants don't seem to be holding out hopes for that, but indications that the conflict isn't drawing in OPEC nations would soothe markets somewhat.

The flip side of that equation is the worst-case scenario -- that Iraq, which reports sending troops toward Israel, will interfere, that the U.S. response to bombing of its naval ship erodes relations with Arab nations, etc.

The immediate fear for the Western world, aside from concerns that the skirmish might develop into a full-scale conflict, is that the flow of oil from the region might drop off. This might happen if a major OPEC nation sympathetic to Arab issues uses productivity to influence the outcome of negotiations.