When the war is over, the world won’t be the same

The International Monetary Fund has produced some scenarios for what might happen when the war on Iran, and its impact on global energy supplies and prices, ends. What it doesn’t do is sketch out the long-term consequences of one of the biggest disruptions to energy markets in history.

The IMF’s “reference” forecast, which assumes the war will end soon and its impact will fade by mid-year, is that global growth will slow from its previous, pre-war, forecast of 3.3 per cent (which it planned to upgrade to 3.4 per cent) to 3.1 per cent. Global inflation is expected to rise from the 3.8 per cent the IMF forecast in January to 4.4 per cent.

Its “adverse” scenario, which envisages large and more prolonged increases in oil and gas prices, sees global growth slowing to 2.5 per cent and inflation reaching 5.4 per cent.

Under its “severe” scenario, which includes more damage to regional energy infrastructure, global growth would fall to only 2 per cent this year and inflation would be above 6 per cent by 2027.

So, the impact of the war that the US and Israel launched, even if it ends soon, will range from quite damaging to severely damaging, with poorer countries, those dependent on imported energy and those inadvertently caught up in the conflict – Iran’s neighbours – hit hardest.

Even those countries, like Australia or, indeed, the US, that export energy aren’t immune from the increase in global energy prices and supply shortages, with the IMF cutting their expected growth rates and increasing their expected inflation rates.

The world won’t allow itself to again be so dependent on such a volatile region, knowing now that Iran can shut down the strait at will.

While Donald Trump and his advisers appear to believe that the supplies of oil and gas and their prices will return to “normal” once the Strait of Hormuz has been re-opened – either by force or by negotiation – that’s improbable and, indeed, the history of previous oil shocks says it won’t happen.

Memories and scars from the closure of the strait, and the near-total halt to the 20 per cent or so of the world’s oil and oil-derived products that used to flow through it, won’t easily be removed from the consciousness of energy-dependent economies and their businesses.

The damage done to the region’s infrastructure – the hub for more than 30 per cent of the world’s oil and gas, a globally vital producer of fertilisers and their pre-cursors, petrochemicals and aluminium – won’t be remedied for months or, in some instances (like Qatar’s LNG facilities), years.

The world won’t allow itself to again be so dependent on such a volatile region, knowing now that Iran can – regardless of whatever deal the Americans are able to eventually negotiate – shut down the strait at will and target the region’s energy infrastructure.

Nor will the developed world, overly reliant on the US for security, trust the US to sort any future conflict out.

The rest of the world had already lost trust in the Trump administration. Its military might have demonstrated its power, but its political leadership has shown an embarrassing absence of any strategic foresight, given that Iran had flagged how it would respond to any attack

Previous oil shocks changed the world.

After the 1973 Arab oil embargo, the world plunged into stagflation (low economic growth, high levels of inflation) and recession. There was global economic turmoil.

In the US, by the end of the decade (and after another oil crisis in 1979) interest rates neared 20 per cent as the Federal Reserve, and its peers, fought to bring inflation under control.

Those 1970s shocks changed the world’s usage of oil, with the oil intensity of economic growth subsequently falling consistently and quite dramatically.

Industries invested in energy efficiency, consumers (even in the US) shifted to smaller vehicles (which led to a boom for the Japanese car industry), a host of new nuclear energy plants were built in Japan and Europe, the fledgling LNG industry was given a tremendous and lasting boost and the seeds for the future growth of renewable energy sources were sown.

Control of the oil industry shifted to a cartel, OPEC, which gave the Middle East geopolitical influence that was cemented by the deal the Nixon administration did to maintain America’s dominance of the world’s financial system after the collapse of the Bretton Woods agreement in 1971.

The US negotiated a deal with the Saudis under which, in return for security guarantees, they pledged to denominate future oil sales in US dollars and use their dollar reserve to acquire US assets. “Petrodollars” since have buttressed the dollar’s dominance.

With the US having now demonstrated to the rest of the world how vulnerable it is to supply disruptions from the Middle East – and how vulnerable the Middle East is to disruption – the demand side of the energy industry’s supply-demand equation will change.

There will be greater effort to reduce the reliance on oil-derived products like gasoline and diesel for transport and power and in energy-intensive industries like steel, aluminium and cement. Renewables and the electrification of transport – electric cars and trucks – will see greater momentum.

There will be attempts to diversify supply.

The US is already benefiting from its war, with a queue of tankers that would normally have sourced their cargoes in the Middle East heading for its shores.

That will, however, flow – and is already flowing – into higher US gasoline and diesel prices (gasoline is $US1 a gallon and diesel more than $US2 a gallon higher than a year ago) and rising discontent among households and those who will vote at this year’s mid-term elections.

That greatly increased international demand will also put pressure on US refineries, which are now themselves scrambling to secure oil and paying higher prices for their feedstock.

Others that could benefit are non-Middle Eastern oil producers, like Brazil, Guyana and Australia, where our vast gas reserves make us well-placed to exploit the inevitable demand within our region for even more LNG.

Regardless of when the conflict ends, it is likely to create a structural change – a risk premium – in the pricing of oil and gas relative to what it might have been had the war never occurred. There will also be increased risk premiums for insurance and shipping – the cost of shipping oil and gas from the Middle East will rise.

It will also have some impact on geopolitics. The US has damaged its reputation and global authority with the war and its hectoring and threats to former allies and, before that, Trump’s trade wars.

China, having built up reserves of more than a billion barrels of oil ahead of the crisis, with access to Russian oil and gas and with the most electrified developed economy (as well as dominance of most of the critical inputs for electrification) emerges stronger.

The increased use of its currency for trade via the strait, which could be a more permanent feature of the post-war environment if Iran can retain control of the passage, will help its ambition of internationalising the yuan.

There will also be lasting macroeconomic effects. In response to the surges in energy prices, countries have been capping and subsidising gasoline and diesel prices, lowering taxes and funding other measures to secure supply and blunt the price effects.

The world was already awash with debt before the war, with most of the developed economies running record levels of debt and deficits.

The war will increase both, leading to greater calls on debt markets, higher interest rates and higher debt-servicing costs for governments that, particularly in the US, have been rolling their maturing debt into ever short maturities to take advantage of the lower interest rates on offer.

The higher debt burdens, on top of the existing overly leveraged starting points, mean further reductions in fiscal flexibility, not just this year but into the future.

Trump’s little “excursion” to the Middle East will leave a costly legacy for the rest of the world, and one from which the US itself won’t be immune.

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