Could this energy crisis be worse for the global economy than COVID?
Despite reports of negotiations between the US and the Iranian regime, the Strait of Hormuz remains effectively closed to most oil tankers, with only a small number of vessels being allowed to pass. The result is a loss of roughly 11 million barrels per day (mbd) of oil and petroleum liquids to the global market. This represents just over 10% of global supply.
At first glance, a 10% disruption may not sound catastrophic. But in oil markets, even a 10% imbalance between supply and demand can have very large economic effects.
To understand the scale of the disruption, it is useful to compare it with the height of the COVID pandemic in 2020. During global lockdowns, empty roads, grounded aircraft and deserted bus and railway stations became normal as travel and economic activity collapsed. At that time, global oil demand fell by about 8mbd, the largest demand shock in history.
Today’s situation is the opposite. Instead of a collapse in demand, the world is experiencing a large supply shock. But the impact on everyday life could end up looking similar: reduced travel, higher transport costs, slower economic activity and pressure on household budgets.
The reason is that both oil supply and oil demand are very inflexible in the short term. People still need to drive to work, goods still need to be transported and aircraft still need fuel. When supply falls suddenly, prices must rise significantly to force demand down.
For now, the release of emergency oil stocks is helping to cushion the initial impact, particularly in developed economies. Members of the International Energy Agency (IEA) are required to hold emergency stocks equivalent to at least 90 days of oil consumption, and several countries also maintain strategic petroleum reserves.
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Countries such as the US, China and Japan can therefore offset supply disruptions for a limited period. However, these reserves are not a long-term solution. If the conflict continues for months rather than weeks, stockpiles will be depleted.
The situation is much more serious for developing countries. Many countries in Asia, Africa and South America hold very limited commercial reserves and are much more vulnerable to supply disruptions and price spikes. For these economies, elevated oil prices quickly translate into higher food prices, inflation and economic instability.
The first shortages would probably appear not in petrol, but in diesel and jet fuel. Gulf oil producers are major exporters of middle distillates, and their crude oil grades produce large quantities of diesel and jet fuel when refined.
Diesel is particularly important because it fuels trucks, ships, construction equipment and agricultural machinery. So a diesel shortage affects food supply, construction, mining and global trade – not just transport. Petrol shortages would follow as crude oil supply tightens further, and eventually shortages would spread across all petroleum products.
Oil is not just used for transport fuel. It is also a key input into petrochemicals for the production of plastics, fertilisers, chemicals, synthetic materials and many industrial processes. This means the effects of a major oil supply disruption spread across the entire economy.
Shortages or price increases could affect everything from food production and packaging to electronics, construction materials and clothing. The economic effects of an oil shock are therefore much broader than simply higher petrol prices.
Protectionism could make everything worse
One of the biggest risks during a supply crisis is export restrictions and protectionism. Governments often try to protect domestic consumers by freezing prices and banning exports of fuel or crude oil, but this usually makes the global shortage worse.
Government price freezes only discourage production and supply, and encourage consumers to keep burning fuel. Protectionism is even worse. There are already signs of this happening – some countries (China, for example) are restricting exports of petroleum products such as diesel and jet fuel. When countries hoard fuel, global markets become tighter and prices rise even further.
The biggest risk would be if the US restricted oil exports in order to protect domestic consumers. The US is now the world’s largest oil producer, producing more than 20mbd of oil and petroleum liquids. But it is also one of the world’s largest consumers. However, it still exports significant volumes, particularly to Europe.
The US has banned oil exports before. In 1975, following the Arab oil embargo (when in 1973 Arab states refused to supply oil to countries, including the US, that had supported Israel in the Yom Kippur war), the US banned exports of crude oil. The ban was lifted only in 2015. If such a ban were introduced today, it would be likely to cause major supply shortages and price increases, especially in Europe.
If the Strait of Hormuz remains closed for a prolonged period, or if the conflict escalates further, global losses of exports from the Persian Gulf could approach the 20mbd of oil and petroleum products.
Under these circumstances, the economic and social effects could be severe. Transport could become more expensive and less frequent, air travel would be severely curtailed, inflation would rise and economic growth would slow significantly. In extreme scenarios, the disruption to daily economic life could resemble the COVID period (and probably worse). But this time it would be caused by a shortage of energy.
For now, markets are relying on emergency stock releases and hopes of a geopolitical de-escalation. But if not, the world economy could face an unprecedented energy shock, with far-reaching and unpredictable consequences.
Adi Imsirovic does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.