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The Iran war is metastasising into a global economic calamity. Ever since the US and Israel launched strikes on the Islamic republic on February 28, financial markets have been lulled by the belief that the conflict would not last long. In turn, they have discounted the threat of a severe disruption to the Strait of Hormuz, through which around a fifth of the world’s oil and liquefied natural gas is shipped. But hostilities are entering a fourth week and the prospects of de-escalation seem to wax and wane every 24 hours. In recent days Israel and Iran have also each inflicted lasting damage on critical regional gas facilities. The worst-case scenarios for investors and policymakers are now coming into view.
In volume terms, a prolonged closure of the strait would amount to a greater oil shock than those triggered by the Yom Kippur war and the Iranian Revolution in the 1970s. The global economy today depends less on oil for energy, but the fuel is still important in transport and industry. Oil prices have risen around 50 per cent to over $100 a barrel since the war started. As traders increasingly assume the region’s oil supply will be locked up for a long time, analysts reckon the price could exceed $150, a level which, if sustained, would raise the probability of a worldwide recession.
The threat to global gas supplies has also become more real this week. Qatari officials said retaliatory Iranian attacks on Wednesday had caused years-long damage to its Ras Laffan LNG plant, the world’s largest, which had already ceased production since March 2 due to earlier drone strikes. Gas prices have surged across Europe and Asia. The blockage of fertiliser, helium and sulphur supplies in the strait is also alarming industries from chipmaking to farming.
Central bankers are in a bind. This week the US Federal Reserve, European Central Bank and Bank of England all reasonably chose to keep interest rates on hold as they evaluate the conflict. The longer energy prices remain elevated, the greater the risk that higher inflation expectations become embedded. But higher rates alongside global economic uncertainty have knock-on consequences too. Equity markets could face a severe correction, dragging down portfolios heavily concentrated in highly-valued tech stocks. Frothy private markets could experience further strain. Sovereign bond yields may also creep higher, as governments contemplate economic support.
Some economies are more vulnerable than others. European nations have swapped dependence on Russia for fossil fuels, with the US. Many have limited fiscal buffers with which to cushion households and businesses from higher global energy prices. They must also compete with Asian nations such as South Korea and Taiwan — which are heavily dependent on the Middle East for oil and gas, and have limited reserves. Developing nations are also facing weaker remittance flows from the Middle East and food shortages. Though America is a net energy exporter, it will not be spared from higher energy prices, particularly with demand surging from data centres.
The longer the conflict goes on, the worse the shortages, price spikes and supply chain disruption will be. Markets and governments cannot quickly adapt to the blockage of the Strait of Hormuz. Even if the war miraculously ends soon, there will be ongoing questions over the security of the waterway. If it survives, the Iranian regime and its supporters know the region can be weaponised any time that tensions with the US and Israel return. Trade, transport and investment in the Gulf won’t be the same again. However it ends, Operation Epic Fury will leave an indelible mark on the world’s economy.