Will Iran inflict oil inflation on the West?
Fire and smoke rise into the sky after an Israeli attack on the Shahran oil depot in Tehran. PhotoMeetings are best avoided, as a rule. They take up valuable time, they achieve little, and they're often just a pretext for one person's terrible idea to be foisted on everyone else. And every now and then, a meeting takes place that sets world history on a dramatic and frightening new course.
On 16 October 1973, the oil-producing nations of the Opec cartel met at the Sheraton Hotel in Kuwait City and agreed to almost double the price of crude oil. In doing so they divided the world along new lines. Economic growth in the West was effectively halved, while the autocracies from which the oil came – Saudi Arabia, Russia – received huge, long-term increases in their current accounts. The US, UK and Europe have spent decades trying to recapture the glory days before that fateful meeting, to rebuild the Western consumer dream that cheap energy had bought – using cheap labour (offshoring, globalisation, historic levels of immigration) and cheap money (privatisation, financialisation, historic levels of borrowing). From a single meeting, the modern dichotomy between oil-rich dictators and debt-laden democracies was agreed.
Of course, the 1973 meeting was really just when the petrostates chose to exercise the power that Western dependence on oil gave them. It was retribution for America's support for Israel in the Yom Kippur War that October; unable to triumph in battle, Opec turned instead to the oil weapon. Now, as then, Iran may decide that Israel's military success will be paid for with inflation and recession in the West.
This is made possible by geography. On Iran's southern coast the Persian Gulf narrows to a channel, 21 nautical miles across at its thinnest, through which 20 million barrels of oil and more than ten billion cubic feet of liquefied natural gas (LNG) are shipped each day. If Iran begins attacking ships in the Strait of Hormuz, it could threaten a fifth of the world's supply of oil and LNG. Ukraine's recent drone attack on Russian bombers demonstrated the power of relatively cheap, easily hidden hardware to wreak havoc on larger targets.
Mines, drones and missiles in the strait could effectively close energy exports from Qatar and Kuwait, while exports from Saudi Arabia, the United Arab Emirates, Iraq and Oman would be restricted. Buyers around the world – especially in China, which buys Iranian oil and Qatari gas – would rush to secure new supply, pushing prices up. Matt Gertken, chief strategist at BCA Research, and Ben May, director of global macro research at Oxford Economics, both predict a major spike in the oil price, which could almost double to around $130 per barrel if Iran decided to block the strait.
The result for Britain, the US and the eurozone would be higher inflation – and therefore higher interest rates to tame it – coupled with lower growth. The effects would be felt first at the petrol station, then in costlier shopping. Oil and gas are not just oil and gas – they are the plastic that most of the things we buy are made from or packaged in (or both); they are also fertiliser and heat and refrigeration and delivery. The price of energy is the price of pretty much everything, from goods made in Chinese factories to produce grown on British farms. In the UK, people, businesses and the government itself are still feeling the effects of the energy price shock of 2022. Our economy has been nudged even closer to recession by Trump's tariffs. The consequence of a doubling of the oil price would, says Gertken, 'very likely be a global recession'.
At time of writing, the markets didn't seem particularly fussed about this suggestion; after a brief spike following Israel's initial attack on Iran on 13 June, the oil price had begun to decline again. Optimists point to the 'tanker war' of the 1980s, in which 55 ships were sunk or significantly damaged by Iran and Iraq, but which did not cause an oil shock. But Gertken says this is a 'mispricing' of the risk, because Israel is not just targeting Iran's nuclear programme but its domestic energy infrastructure. It is, he says, aiming not only to defang Iran's military but to cause unrest and regime change, to depose its 86-year-old Supreme Leader, Ali Khamenei. The current Iranian regime therefore has little to lose by escalating a situation in which Israel is already an unrestrained aggressor, and Iran has shown an appetite for targeting international shipping through proxy groups such as the Houthis in Yemen. Gertken puts the likelihood of a major oil shock at 50 per cent.
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Who wins from this? While drivers in the US would be dismayed by prices at the petrol pump, Americans would be relatively well insulated from the shock because the US is the world's biggest producer of fossil fuels and a net exporter of energy. Russia, too, would benefit from a higher oil price, because fossil fuel exports are a major component of the Kremlin's revenues. China and Europe, which rely more on manufacturing, are far more exposed to a slump in global demand. Faced with another wave of inflation, European countries might find it harder to impose sanctions on Russian energy, and a ceasefire on Vladimir Putin's terms might become more likely. Global politics will continue to be redrawn – crudely, messily, and in black – until we can give up our fatal addiction to oil.
[See also: Labour needs to be honest about tax rises]
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