As readers will know, the global economy is in the early stages of an energy price shock driven by the ongoing conflict in the Middle East and the effective closure of the Strait of Hormuz. This particular crisis is both difficult to write about and clouded in uncertainty. As with any geopolitical issue, and especially one in which President Trump is a key decision maker, things can change very quickly.
For global energy markets – and leaving to one side the other important markets from fertiliser, to helium, to aluminium directly impacted by the closure of the Strait – the extent and magnitude of the price shock will be governed by two factors. The first is the duration of the closure of the Strait. The Strait has now been closed for almost three weeks – itself a once almost unimaginable scenario – which creates a major problem for the flow of global crude, refined products, and LNG. Some of that missing flow can be rerouted, via pipelines, to either the Red Sea or to ports in the southern United Arab Emirates but most cannot. The worst impacts of that missing flow are yet to be felt as tankers which left before the war are still, in many cases yet to arrive at their final destinations and local stockpiles can often be drawn down. The consensus amongst analysts though is the impacts will mount up and become more severe with each passing week.
And even if the Strait was to reopen tomorrow, the relief would not be immediate. As storage limits have been hit, production capacity in many Gulf states has been cut back. Restarting could take several weeks, before one even considers the fact that much of global shipping capacity is now effectively in the wrong place.
The second factor, one which has gripped markets this week, is the possibility of lasting damage to both upstream and downstream energy infrastructure in the region. Qatar reckons that the damage from a hit on its LNG facilities this week will reduce its supply of LNG by up to 17% for 3 to 5 years. Given Qatar is responsible for around 20% of global LNG supplies, that alone will likely have a material impact on world markets.
This week, the Clark Center’s US and European Economic Expert Panels looked at some of the potential policy responses to the energy shock which are currently on the table.
The United States is in a relatively better position than Europe (and both seem better placed than much of Asia) to weather the storm. But while the United States may be an energy exporter that will be cold comfort to most American consumers. A rising energy price redistributes income away from energy consumers and towards energy producers and most Americans do not work directly in fields exposed to the potential gains.
The obvious immediate pain point in the United States is gas prices. Given that US taxes on gas are much lower than those charged in Europe, the underlying commodity price makes up a much greater proportion of what drivers pay at the pump. This means that while prices are lower overall, they rise much more in percentage terms during a price shock.
There are, other than reopening the Strait, few good options. The US experts, for example, broadly disagreed that “the release of strategic oil reserves announced by the International Energy Agency will deliver substantially lower US gasoline prices at the pump over the next six months than would otherwise have been the case”, with more than half of respondents – weighted, as ever, by confidence – disagreeing or strongly disagreeing. Given the release date of flows from strategic reserves vs the lost Gulf output, the impacts may well only be marginal.
There was stronger, but still weak, support for the ideas that “assuming that world oil prices over the next six months continue to be elevated and volatile, temporarily suspending the federal gasoline tax would deliver substantially lower gas prices at the pump than otherwise over that period”. Just over half of respondents either agreed or strongly agreed, although with a substantial proportion disagreeing. Of course, lowering the price paid at the pump would diminish what is, after all, a fundamentally driven price signal. The problem is a shortage of refined products and demand for those products would have to be pushed down one way or another.
There was no support for the idea that a gasoline price cap could be introduced without inducing scarcity.
In Europe, the issues are more widespread. An energy price spike there could have much wider implications for household budgets and the profit margins of firms.
The European experts were a little more optimistic than their US peers that releases from strategic reserves could lower the prices for vehicle fuels but still far from collectively convinced.
More interestingly, the panel was asked whether “assuming that world commodity prices over the next six months continue to be elevated and volatile, temporarily subsidising or capping natural gas prices would be an effective way to protect European households and businesses from high energy bills”? A plurality of 40% were uncertain. This, of course, would be the 2022 playbook for most European states. But that proved extremely expensive for European governments and, with government bond yields on the rise, finance ministries may prove wary.
Where there was widespread agreement was on the issue of renewable energy. More than 90% of respondents agreed or strongly agreed that “the vulnerability of the European economy to high and volatile fossil fuel prices indicates the need for stronger incentives to promote decarbonisation rather than rolling back on policy support for the energy transition”.
The problem of course is that this is not something which can be achieved on a timeframe of weeks and months. In the short run, a prolonged closure of the Strait of Hormuz means real economic hardship with no easy answers.
