AN ATTACK ON THE WORLD ECONOMY / THE ECONOMIST

Beyond oil

An attack on the world economy

Whatever happens in the Strait of Hormuz, energy markets have been changed for ever

Illustration: Ben Hickey

Having DISCOVERED the costs of tariffs, President Donald Trump has now discovered the costs of war. 

On March 9th he declared that his campaign against Iran would be over “very soon”, sending oil prices, which had peaked at nearly $120 a barrel the day before, crashing to nearly $80 (before the war they had been $70). 

Iran’s de facto closure of the Strait of Hormuz has blocked roughly 15% of global oil supply. 

Mr Trump, facing midterm elections and voters weary of inflation, is signalling that he cannot bear those costs—just as he retreated from his trade war after markets buckled last spring.

Yet Mr Trump is as chaotic in matters of war and peace as he is in economic policy. 

As we published this, the strait remained all but closed after Iran had struck shipping there. 

The oil price had rebounded to around $100. 

Meanwhile, American rhetoric remained belligerent, as Pete Hegseth, the secretary of war, promised to fight on harder than ever.

The confusion betrays the president’s lack of good options. 

Whereas de-escalating the trade war is more or less in his gift, he cannot restore the old energy market. 

Whatever happens, the world is entering a new era of energy insecurity.

The shock the war has unleashed could be huge. 

True, the world depends less on oil than it did in 1973, when an Arab embargo caused crude prices to quadruple, or 1979-80, when the Iranian revolution and the Iran-Iraq war hit supply. 

Then, it was still common to burn oil to produce electricity. 

Today it is used less widely, mainly to power transport and make petrochemicals.

Yet this evolution is double-edged. 

Today’s oil demand is stubborn, so prices have to rise more for a given disruption of supply. 

And this one is extreme: the loss of supply is greater than in either 1970s shock. 

Even at the worst moments of the crisis, traders have not come close to pricing in an indefinite closure of the strait. 

The oil price required to bring demand into line with supply in such a scenario could be over $150 per barrel.

Members of the International Energy Agency can draw on 1.8bn barrels of emergency stocks and they are releasing 400m. 

But access is often throttled by pipelines or other constraints. 

Even China, which has built up a separate vast stockpile, has seen the need to stop exports of some refined products. 

The fact that transport is a key input to so much of the world economy means that bottlenecks could cause grave harm.

And the shock is not limited to oil. Qatar’s main liquefied natural gas (LNG) export facility remains closed after a drone strike, taking nearly a fifth of global supply off the market. 

An expansion of its output has also been postponed. 

The loss of Qatar’s exports has set off a scramble in Asia. 

In Europe, where gas storage-tanks are unusually empty for the time of year, prices are up by more than half. America could export more LNG, but its demand for natural gas is rising, because of the boom in energy-hungry data centres.

Iran could drag the war out to try to suggest that it and not Uncle Sam is calling the shots. 

On March 11th Iran hit three cargo ships in the Strait of Hormuz and, later, two tankers near Iraq. 

Like Yemen’s Houthi rebels, who have successfully attacked shipping in the Red Sea with low-tech weaponry despite NATO members’ high-tech efforts to stop it, the Iranian regime has learned that it can lob drones at ships and energy infrastructure while being flattened by bombs.

Even when the war ends the world will have changed. 

Iran’s new hardline supreme leader, Mojtaba Khamenei, now knows that energy prices are America’s weak spot. 

In Ukraine, which has tested drone defences, some Iranian-style machines still get through. 

American troops are not about to occupy Iran to stop the launches. America does not have the capacity to defend every tanker, even if it provides them with cheap insurance. 

Disruption to energy markets will therefore come and go with geopolitical tensions, especially if Iran concludes that it needs a nuclear weapon to be safe.

That is the new reality in which investors, businesses and policymakers must now operate. 

For investors, the contrast between an increasingly volatile world and buoyant equity markets just became more stark. 

Chaos in the Middle East joins a long list of threats to markets, including gloomy scenarios related to artificial intelligence, trouble in private credit and a loss of faith in indebted governments. 

Government-bond yields have risen since the crisis began, especially in southern Europe and Britain, which depends on imported LNG.

Businesses face a new risk premium, as energy prices reflect the ever-present danger of conflagration. 

As after the pandemic and start of the Ukraine war, they must again pore over their supply-chain risks, including their exposure to the Gulf economies, whose reputations for stability have been shaken and which can expect less investment and fewer tourists.

For policymakers, painful decisions loom. 

Energy storage is part of the solution. 

It was foolish of Mr Trump not to replenish America’s oil reserves at the low prices that prevailed before the war. 

Adding to emergency stocks will now cost more. 

High prices should induce more supply outside the Middle East. 

Until it does, countries like America may find it hard to resist the lure of energy protectionism. 

When oil producers and refiners, including China and India, start to restrict exports in an attempt to protect their consumers from high prices, the damage to other countries can be severe.

Central banks will have to cope with a renewed inflationary threat that heightens the risk of both recession and wage-price spirals. 

And politicians will face voters clamouring for energy subsidies, like the support doled out in the rich world after Russia invaded Ukraine, which exceeded 2.5% of GDP in many European countries, adding to their debts. 

That would shift the pain to poorer countries, especially in Asia; in 2022 Bangladesh endured blackouts. 

It is difficult to predict how this crisis ends. 

But even if countries get policy right, it is already clear that the war has made the world economy less prosperous, more volatile and harder to govern.