The ripples of the Iran energy crisis

Rising fuel prices are threat­en­ing growth and stok­ing infla­tion, as sup­ply short­ages, strained refiner­ies and opaque mar­kets cre­ate fresh risks for the global eco­nomy.

By Mal­colm Moore and Sam Flem­ing

Just as the global eco­nomy seemed to be shak­ing off its fever from this year’s energy crisis, the tem­per­at­ure is rising again and the pro­gnosis is worsen­ing. The price of crude oil has pushed past $100 this month and infla­tion­ary pres­sures are mount­ing in the US, the EU and the UK. Fuel price protests have broken out from Syria to Guatem­ala, while India and the Phil­ip­pines have intro­duced emer­gency energy-sav­ing meas­ures.

The sum­mer was char­ac­ter­ised by what many see in ret­ro­spect as a false sense of secur­ity. In June the US and Iran signed a deal to extend their fra­gile truce and reopen the Strait of Hor­muz, the world’s main oil choke­point, allow­ing over 130 tankers to escape the Gulf and deliver their car­goes to the world.

The deal soon col­lapsed, and there now seems little pro­spect of a speedy end to the con­flict, even as the Rus­sia-Ukraine war puts fur­ther pres­sure on energy prices. Many experts warn that the oil and gas mar­ket may be dan­ger­ously tight in the autumn and winter, with ser­i­ous con­sequences for infla­tion and growth. Joe Brusuelas, chief eco­nom­ist at account­ing firm RSM US, warns the world has entered “oil shock 2.0”. He adds that cent­ral banks will need to “slow down the global eco­nomy if they want to push the infla­tion genie back into the bottle”.

But the energy price shock is not what many people think it is. Here are five ways in which it is wrong­foot­ing the world.

Eco­nom­ists were too pess­im­istic. Nowthey face the oppos­ite prob­lem

To date, global growth has defied many eco­nom­ists’ fore­casts, partly because the oil and gas trade turned out to be unex­pec­tedly resi­li­ent after the US and Israel attacked Iran on Feb­ru­ary 28.

Fatih Birol, the head of the Inter­na­tional Energy Agency, warned in March that the world was facing “the greatest global energy secur­ity threat in his­tory”, refer­ring to the scale of oil and gas cut off from global mar­kets. But although coun­tries began pre­par­ing for short­ages of key fuels, prices never broke through pre­vi­ous records because of a co-ordin­ated release of 400mn bar­rels of stra­tegic reserves, the with­drawal of China from buy­ing crude and the robust­ness of the global trad­ing sys­tem.

The world eco­nomy grew at the same annu­al­ised pace in the second quarter of the year as in the first, accord­ing to cal­cu­la­tions by Cap­ital Eco­nom­ics, a research firm. Those num­bers omit the six Gulf Cooper­a­tion Coun­cil nations, which include Saudi Ara­bia, the world’s top oil exporter, the United Arab Emir­ates, and Qatar, the second-largest pro­du­cer of lique­fied nat­ural gas.

Isa­belle Mateos y Lago, group chief eco­nom­ist at BNP Pari­bas, sees such eco­nomic resi­li­ence as the res­ult of a “tug of war” between the AI boom, which has stoked growth, and the energy crisis. She thinks the trend can con­tinue, not­ing the scale of cap­ital expendit­ures on data centres and AI.

But the price pres­sures are mak­ing them­selves felt. On Wed­nes­day, the US Fed­eral Reserve raised interest rates for the first time since 2023; it is far from the only cent­ral bank apply­ing the brakes in response to the infla­tion­ary pres­sures caused by the war.

Last week the European Cent­ral Bank warned of “risks to the upside” for infla­tion and to the “down­side” for eco­nomic growth, as it increased rates for the second time since the seven-month-old war began. On Fri­day, the Bank of Japan took its rate to a 31-year-high. Neil Shear­ing at Cap­ital Eco­nom­ics warns that if crude oil prices hover between $110 and $120 a bar­rel for the next six months, global growth would fall towards 2 per cent — much less than last year’s rate of 3.5 per cent. “It would start to feel pretty reces­sion­ary,” he says.

Fears of slower growth as cent­ral banks increase bor­row­ing costs are also feed­ing back into the oil mar­ket, poten­tially put­ting a ceil­ing on crude prices.

This is a fuel crisis, not an oil crisis

The price of crude oil has tra­di­tion­ally been the warn­ing sig­nal for the global eco­nomy. But con­sumers do not buy crude oil, they buy pet­rol, diesel and jet fuel, and it is the price of these fuels that ulti­mately feeds through into infla­tion.

Over the course of the Iran war, fuel mar­kets have been far tighter than crude mar­kets because of a short­age of capa­city to refine oil into fuel and the high cost of ship­ping.

As early as June, even as crude oil prices were com­ing down, Tom Baker, the head of oil trader Vitol in the Middle East, was warn­ing about a gloomy out­look for refined fuels for the rest of this year. That month, China’s inde­pend­ent refiner­ies cut pro­duc­tion to a nine-year low after a gov­ern­ment ban on exports left them unable to sell fuel over­seas.

In Rus­sia, the world’s third-largest refiner after the US and China, a sus­tained cam­paign of drone attacks by Ukraine has reduced pro­duc­tion by 30 per cent in the past year to its low­est level in over ttwo dec­ades.

By August, exports of diesel from the huge refiner­ies in the Middle East had fallen to a quarter of their pre­war level accord­ing to the IEA, which has been coordin­at­ing the response to the crisis.

The world’s refiner­ies have been run­ning at full speed. But they have been unable to catch up with the losses. Global out­put of refined fuels was over 4mn bar­rels a day lower in August than a year earlier, accord­ing to the IEA.

This month, the price of diesel in the US and Europe passed $200 a bar­rel and US diesel prices passed $6 a gal­lon for the first time ever, almost double their pre­war level. Diesel, which is essen­tial for truck­ing, as well as for heat­ing in the winter, accounts for almost a third of global oil demand.

Things could get worse. China, which allowed its refiner­ies to start export­ing fuel again over the sum­mer, is thought to be con­sid­er­ing a fresh ban after see­ing its domestic fuel stocks fall. If Beijing halts exports a second time, fuel prices will be under severe pres­sure.

This is not an old-fash­ioned oil shock

Even at $110 a bar­rel, oil is not as expens­ive as it used to be. The record price for a bar­rel of Brent crude was $147.50 in 2008, the equi­val­ent of $230 a bar­rel today when adjus­ted for infla­tion. Oil aver­aged more than $110 a bar­rel in 2011 and 2012, or $165 in today’s money.

Nor has the price rise been as steep as in the past: between 1973 and 1974, after Arab pro­du­cers imposed an embargo in response to west­ern sup­port for Israel in the Yom Kip­pur war, prices quad­rupled to $12 a bar­rel (worth $82 today).

Oil pro­duc­tion is also less con­cen­trated in the Middle East. The US is now the world’s largest pro­du­cer, ensur­ing it will not have a sup­ply short­age. More import­antly, a bar­rel of oil mat­ters less to the global eco­nomy than it used to.

Oil’s share of global energy demand has fallen below 30 per cent from a peak of 46 per cent half a cen­tury ago. When the Iran war began, by con­trast with the 1970s energy shock, the world had stra­tegic reserves, an oil glut and grow­ing sup­plies of lique­fied nat­ural gas.

Still, higher hydro­car­bon prices have already led to changes in beha­viour, such as a faster pace of elec­tric vehicle sales in Europe and Asia. Over the past seven months, Chinese pet­ro­chem­ical plants have cut pro­duc­tion, air­lines have trimmed mar­ginal routes and Asian coun­tries have switched from gas to other fuels, includ­ing coal.

Gas prices have also risen 160 per cent since the war star­ted and have been rising fur­ther in recent weeks. The con­tin­ent is approach­ing winter without its usual backup stores.

Poor coun­tries get hit the hard­est

Protests broke out in Syria this week after the gov­ern­ment raised diesel prices by 40 per cent and pet­rol by nearly 30 per cent, due to what it called “an excep­tional increase in the global cost of pro­cure­ment”.

Bangladesh and Pakistan have both struggled to import gas. Res­taur­ants across India were forced to close because they had run out of lique­fied pet­ro­leum gas. The Phil­ip­pines declared a national emer­gency and man­dated work­ing from home.

By far the most com­mon response to the crisis, accord­ing to the IEA, has been to shield con­sumers, with 94 coun­tries cut­ting taxes, cap­ping prices or sub­sid­ising fuel. So far, most coun­tries have avoided unrest but at vast expense.

The west has been rel­at­ively untroubled — so far. But while the price of pet­rol in the US remains far below Europe and else­where — due to lower taxes — the $5 a gal­lon now charged in some states is around the national peak reached in the Biden admin­is­tra­tion. It is not the eco­nomic back­drop Pres­id­ent Don­ald Trump wanted for the US midterm elec­tions on Novem­ber 3.

The oil industry is also in the dark

Oil and gas exec­ut­ives have warned about the loom­ing crisis but have so far res­isted mak­ing pre­dic­tions about what it means for energy prices.

In part, that is because they do not know, one energy exec­ut­ive privately acknow­ledges. Many com­pan­ies in the sec­tor expec­ted prices to soar after one­fifth of the world’s oil and gas sup­plies were cut off. Instead, traders have reg­u­larly sold down their pos­i­tions dur­ing the seven-month war, often react­ing to claims from the White House that a peace deal was immin­ent.

The US pub­lishes weekly data on its oil stocks. But many coun­tries only release such inform­a­tion monthly, and China, the world’s largest importer of oil, does not release reg­u­lar fig­ures at all.

The mar­ket has swung wildly because it has been fly­ing blind, with no accur­ate and timely data on how much oil the world has in reserve, or on con­sumer demand. “Those are the two most import­ant things to know and we do not know either of them,” says the exec­ut­ive.